INTERMEDIATE EXAMINATION - The Institute of Cost Accountants of [PDF]

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[ December ¯ 2011 ]

INTERMEDIATE EXAMINATION (REVISED SYLLABUS - 2008)

GROUP - II Paper-8 : COST AND MANAGEMENT ACCOUNTING Q. 1. (a) Match the statement in Column 1 with the most appropriate statement in Column 2 : Column I Value analysis Performance of public enterprise Balance score card Residual income Variance analysis

Column II Performance analysis Management by exception Measures divisional performance Technique of cost reduction Shows profitability and capacity utilisation

Q. 1. (b) State whether the following statements are True (T) or False (F) : (i) (ii) (iii) (iv) (v)

Profit planning and control is not a part of budgetary control mechanism. Cost industry makes use of output costing. Idle time variance is always adverse. Ash produced in thermal power plant is an example of co-product. The stock turnover ratio indicates the slow moving stocks.

Q. 1. (c) In the following cases one out of four answers is correct. You are required to indicate the correct answer and give reasons for answer : (i) The cost data pertaining to Product “X” of XL Ltd. are as follows : Maximum capacity 30,000 units Normal capacity 15,000 units Increase in inventory 1,880 units Variable cost per unit Rs. 12 Selling price per unit Rs. 50 Fixed manufacturing overhead costs Rs. 3,60,000 If the profit under Absorption costing method is Rs. 1,01,000, the profit under Marginal costing method would be A. Rs. 1,46,120 B. Rs. 1,23,560 C. Rs. 55,880 D. Rs. 73,340

2

[ December ¯ 2011 ]

Revisionary Test Paper (Revised Syllabus-2008)

(ii) Which of the following does not influence the use of activity-based costing? A. High proportion of overhead costs B. Product complexity C. Monopoly position D. Volume diversity (iii) Budgeted sales for the next year is 5,00,000 units. Desired ending finished goods inventory is 1,50,000 units and equivalent units in ending W-I-P inventory is 60,000 units. The opening finished goods inventory for the next year is 80,000 units, with 50,000 equivalent units in beginning W-I-P inventory. How many equivalent units should be produced A. 5,80,000 B. 5,50,000 C. 5,00,000 D. 5,75,000 (iv) A company maintains a margin of safety of 25% on its current sales and earns a profit of Rs. 30 lakhs per annum. If the company has a profit volume (P/V) ratio of 40%, its current sales amount to — A. Rs. 200 lakhs B. Rs. 300 lakhs C. Rs. 325 lakhs D. None of the above (v) In a process account, abnormal losses are valued A. The same as good production B. At their scrap value C. At the cost of raw material D. At good production cost less scrap value Q. 1. (d) Fill in the blanks suitably : (i) (ii) (iii) (iv) (v)

A cost which does not involve any cash outflow is called Efficiency is basically a ratio of and . Work study consists of and . In absorption costing cost is added to inventory. Costing reduce the possibility of under pricing.

or

Answer 1. (a) Column I Value analysis Performance of public enterprise Balance score card Residual income Variance analysis

Column II Technique of cost reduction Shows profitability and capacity utilisation Performance analysise Measures divisional performance Management by exception

.

Group-II : Paper-8 : Cost & Management Accounting

[ December ¯ 2011 ]

3

Answer 1. (b) (i) False. (ii) True. (iii) True. (iv) False. (v) True. Answer 1. (c) (i) C- Rs. 55,880 Fixed cost per unit = Rs. 3,60,000 / 15,000 units = Rs. 24 Profit under absorption costing = Rs. 1,01,000 Adjustment of fixed manufacturing overhead costs of increased inventory = 1,880 units × Rs. 24 = Rs. 45,120 Profit under marginal costing = Rs. 1,01,000 – Rs. 45,120 = Rs. 55,880 (ii) C – Monopoly position. (iii) A - 5,80,000 Using production related budgets, units to produce equals budgeted sales + desired ending finished goods inventory + desired equivalent units in ending W-I-P inventory – beginning finished goods inventory – equivalent units in beginning W-I-P inventory. Therefore, in this case, units to produce is equal to 5,00,000 + 1,50,000 + 60,000 – 80,000 – 50,000 = 5,80,000. (iv) B - Rs. 300 lakhs Margin of safety = Profit/ P/V Ratio = 30/0.40 = Rs. 75 lakhs 0.25 of sales = Rs. 75 lakhs Hence, Sales = 75/0.25 = Rs. 300 lakhs (v) A – The same as good production Answer 1. (d) (i) Notional cost, Imputed cost (ii) Input, Output (iii) Method study, time and motion study (iv) Fixed (v) Absorption Q. 2. Write short notes on : (i) Role of costs in pricing (ii) Incremental Pricing (iii) Two-part Transfer Pricing System (iv) Role of Cost Accountant in Material Cost Control (v) Opportunity cost

4

[ December ¯ 2011 ]

Revisionary Test Paper (Revised Syllabus-2008)

Answer 2. (i) Cost data constitute the fundamental element in the price setting process. Higher costs including promotional expenses involved in connection with advertising or personal selling as well as taxation may necessitate an upward adjustment of price. If costs go up, price rise can be quite justified. However, their relevance to the pricing decision must neither be under –estimated nor exaggerated. No company should charge prices below full costs unless such a policy appears necessary or expedient in the short period. Costs are just one of the several factors to be considered in a pricing decision and for pricing purposes, costs are best regarded as floor below which a company will not normally price its products. Costs determine the profit consequences of the various pricing alternatives. Cost calculations may also help in determining whether the product whose price is determined by its demand is to be included in the product line or not. Though in the long run, all costs have to be covered for managerial decisions. In the short run direct costs are more relevant. In a single product firm, all costs are direct costs with respect to the product. In multi product firm, for pricing decisions, relevant costs are those costs that are directly traceable to an individual product. In addition, it must contribute to the common costs and to the realization of profit. Answer 2. (ii) Incremental Pricing involves comparison of the impact of decisions on revenues and cost. If a pricing decision results in a greater increase in revenue than in costs, it is favourable. Profitability is identified as the primary consideration and then the decision is adjusted to bring it in consonance with the other decisions of the business. Incremental pricing analyses all aspects of decision-making as listed below : (a) Relevant cost analysis – This technique considers changes in costs rather than in Average Cost. Overhead allocations are irrelevant. Incremental revenue inflows and Cost outflows are included for decision-making. (b) Product-line relationship analysis – This technique necessitates consideration being given to possible complementary relations in demand. Sale of one product may lead to the sale of a complementary product. This overall effect on profitability has to be evaluated. (c) Opportunity cost analysis – Incremental revenue should cover Opportunity Cost and also generate surplus. A price, which results in an Incremental Revenue, which in turn merely covers the Incremental Costs, is not sufficient. If opportunity costs exceed Incremental Revenue, the decision is not sound. (d) Time factor analysis – The decision should take into account the short-run and long-run effect. A high price may increase its immediate profits but may lead to loss of revenue in the long-run owing to competitors snatching the business. (e) CVP analysis – In fixing prices, consideration should be given to Price-Volume relationship. The responsiveness of the market to the price should be such that the volume is increased to achieve full utilization of plant capacity. (f) Risk analysis – Consideration should also be given to the evaluation of uncertainty and risk factor. The decision taken should be able to maximize the expected value, based on Probability Theory. Answer 2. (iii) This is one method of resolving Transfer-Pricing disputes between a Division and the company as a whole. Under this method, Transfer Price = Marginal Cost + Lump-sum fixed fee. This method is most suited when there is no market for the intermediate product, and the Transferring Division has no capacity constraints. The transferring Division is provided with sufficient incentive for internal transfer, since Marginal Costs are fully recovered will reduce its losses by recovering Fixed Costs. The recipient division is also interested in the internal procurement since the Transfer Price will be

Group-II : Paper-8 : Cost & Management Accounting

[ December ¯ 2011 ]

5

less than the Market Price or Cost of alternative option like outsourcing etc. Moreover, the lump-sum fixed fee constitutes a commitment of the recipient division to utilize a portion of the capacity of the Transferring Division, for an agreed compensation. Answer 2. (iv) The Cost Accountant may be involved in – (a) Scheduling – Helping to prepare schedule for materials requirements by co-ordinating with production planning and purchase departments, and to provide estimate of material cost. (b) Cost assignment – Tracing materials issued to cost units or jobs undertaken or to overheads (through requisition notes) so that the actual costs of output can be assessed (or estimated) and the profitability or individual products or jobs can be determined. (c) Variance analysis – Reporting the costs of material losses by calculating Material Usage Variance and indicating the same to production management. Monitoring the cost of material purchases and the efficiency of the Purchasing Department by means of Material Price Variance. (d) EOQ – Providing information about cost of ordering stocks and stock holding so as to enable stores management to determine the optimum order size for stocks, which will minimize store-keeping costs. (e) Substitution – Providing information on whether it would be more profitable to alter the material specifications of individual products or to alter the material mix, by introducing cheaper substitute materials. (f) Accounting – Reviewing the material accounting procedures to ensure that goods ordered are received, checked, invoiced and paid for properly. Answer 2. (v) Opportunity cost is the value of sacrifice made or benefit of opportunity foregone by selecting one alternative in preference to other alternatives. It is the prospective change in cost following the adoption of an alternative machine, process, raw materials, specification or operation. Opportunity cost is a relevant cost where alternatives are available. However, opportunity cost does not find any place in formal accounts and is computed only for comparison purposes. It is the cost of opportunity lost by diversion of an input factor from one use to another. it is the maximum contribution that is foregone by using limited resources for a particular purpose. It represents the measurable value of opportunity bypassed by rejecting an alternative use of resources. Opportunity cost is taken into consideration when alternatives are compared. When a number of alternatives are available, the highest of the opportunity cost will be considered for decision-making. For example, the opportunity cost of funds invested in a project is the interest that could have been earned by investing the funds in bank deposit or other risk free modes. Q. 3. (a) Madhav has a small furniture factory and specializes in the manufacture of small tables of standard sizes of which he can make 30,000 a year, he made and sold 20,000 tables and his cost per table was Rs. 110, made up as under – (i) Materials Rs. 60; (ii) Labour Rs. 20 and (iii) Overhead (Fixed) recovered at 50% of Material cost Rs. 30. Prices are fixed by adding a standard margin of 15% to the total cost arrived at as above. For the current year, due to a fall in the cost of materials, total cost was determined at Rs. 95 per table as under – (i) Materials Rs. 50; (ii) Labour Rs. 20 and (iii) Overhead (Fixed) recovered at 50% of Material cost Rs. 25.

6

[ December ¯ 2011 ]

Revisionary Test Paper (Revised Syllabus-2008)

Madhav maintained his standard margin at 10% of his total cost of sale. Sales were at the same level as in the previous year. You are required to – (i) Determine profit and loss for the current year. (ii) Compute the price that should have been charged in the current year to yield the same profit as in previous year. (b) Metaliks Ltd. uses a small casting in one of its finished products. The castings are purchased from a foundry. Metaliks Ltd. purchases 72,000 castings per year at a cost of Rs. 1,000 per casting. The castings are used evenly throughout the year in the production process on a 360-day-peryear basis. The company estimates that it costs Rs. 11,000 to place a single purchase order and about Rs. 500 to carry one casting in inventory for a year. The high carrying costs result from the need to keep the castings in carefully controlled temperature and humidity conditions, and from the high cost of insurance. Delivery from the foundry generally takes 8 days, but it can take as much as 12 days. The days of delivery time and percentage of their occurrence are shown in the following tabulation : Delivery time (days) : 8 9 10 11 12 Percentage of occurrence : 75 10 5 5 5 Required : (i) Compute the economic order quantity. (ii) Assume the company is willing to assume a 15% risk of being out of stock. What would be the safety stock? The re-order point? (iii) Assume the company is willing to assume a 5% risk of being out of stock. What would be the safety stock? The re-order point? (iv) Assume 5% stock–out risk. What would be the total cost of ordering and carrying inventory for one year? (v) Refer to the original data. Assume that using process re-engineering the company reduces its cost of placing a purchase order to only Rs. 700. In addition, company estimates that when the waste and inefficiency caused inventories are considered, the true cost of carrying a unit in stock is Rs. 850 per year. 1. Compute the new EOQ. 2. How frequently would the company be placing an order, as compared to the old purchase policy? Answer 3. (a) Statement of Cost and Profit Particulars

Last year (20,000 tables) This year (20,000 tables) Remarks Per table Total Per table Total Materials 60.00 12,00,000 50.00 10,00,000 Labour 20.00 4,00,000 20.00 4,00,000 Prime cost 80.00 16,00,000 70.00 14,00,000 Add : Overheads 30.00 6,00,000 30.00 6,00,000 Fixed OH is constant Total cost 110.00 22,00,000 100.00 20,00,000 Add : Profit 16.50 3,30,000 9.25 1,85,000 Balancing figure Sales 126.50 25,30,000 109.25 21,85,000 SP = 95 + 15% =109.25 Note : It is assumed that Madhav would have determined the SP based on his cost estimate of Rs. 95.

Group-II : Paper-8 : Cost & Management Accounting

[ December ¯ 2011 ]

7

Price to be charged for earning the same profit as in the previous year : Required profit Rs. 3,30,000 Add : Revised costs for the current year Rs. 20,00,000 Desired sales revenue Rs. 23,00,000 (for 20,000 tables) Hence, selling price per table Rs. 115.00 Answer 3. (b) (i) Economic Order Quantity Annual consumption of raw material = 72,000 castings Ordering cost per order = Rs. 11,000 Carrying cost per casting p.a. = Rs. 500 Economic order quantity

=

2 × 72,000 × 11,000 = 1,780 castings 500

(ii) Safety stock assuming 15% risk of being out of stock Delivery time is usually 8 days, but may extend to 12 days. After observing the given percentage of occurrences, it may be noted that 15% risk of being out of stock, means that a stock of 9 days is kept in hand while placing the order (percentage of occurrences of 10th, 11th and 12th days is 5% + 5% + 5% = 15%). Average consumption per day = Safety stock Re-order point

= = = =

72,000 Annual Consumption = 360 days = 200 360 days

1 day consumption (i.e. 9 days – 8 days) Safety stock + Lead time consumption 1 day consumption + 8 days consumption (1 × 200) + (8 × 200)

= 200 castings

= 1,800 castings

(iii) Safety stock assuming 5% risk of being out of stock 5% risk of being out of stock means that a stock of 11 days is kept in hand while placing the order (the chance of delivery time being 12 days is 5%). Safety stock = 3 days consumption (i.e. 11 days – 8 days) = 3 × 200 = 600 castings Re-order point = Safety stock + Lead time consumption = 3 days consumption + 8 days consumption = (3 × 200) + (8 × 200) = 2,200 castings (iv) Total cost of ordering and carrying inventory at 5% stock out risk If EOQ is adopted and a safety stock of 600 castings is maintained, then the total cost of ordering and carrying inventory is computed below : Total cost or ordering = Total carrying cost

72,000 × Rs. 11,000 1,780

= Rs. 4,44,944

= Carrying cost of avg. inventory + Carrying cost of safety stock

⎡ 1,780 ⎤ = ⎢ × Rs. 500⎥ + [600 × Rs. 500] ⎣ 2 ⎦

=

Rs. 7,45,000

8

Revisionary Test Paper (Revised Syllabus-2008)

[ December ¯ 2011 ]

(v) (1) New Economic Order Quantity Annual consumption of raw material Ordering cost per order Carrying cost per casting p.a. Economic order quantity

= 72,000 castings = Rs. 700 = Rs. 850 =

2 × 72,000× 700 850

= 344 castings

(2) Comparison of frequency of orders Annual requirement of castings Order size = EOQ Number of orders Frequency of orders [360 days ÷ no. of orders]

Old policy

New policy

72,000 1,780 40 9

72,000 344 209 1.7

Q. 4. (a) Jagannath Ltd. manufactures two products X & Y. The company had budgeted Factory OH of Rs. 2,55,000 and budgeted Direct Labour Hr. of 150,000 hours. So, the OH recovery rate was predetermined at Rs. 1.70 per DLH., and used by the Company for Product Costing purposes. The department-wise break-up of the OH and DLH were – Particulars

Department A

Department B

Rs. 1,80,000 75,000 hours Rs. 2.40

Rs. 75,000 75,000 hours Re. 1.00

Budgeted OH Budgeted DLH Rate per DLH

Total Rs. 2,55,000 1,50,000 hours Rs. 1.70 (plant-rate)

You are further informed that – • Each unit of Product X requires 4 hours in Department A and 1 hour in Department B. Also, each unit of Product Y requires 1 hour in Department A and 4 hours in Department B. • This was the first year of the Company’s operation. There was no WIP at the end of the year. However, 1,500 and 4,500 units of Products X and Y were on hand at the end of the year. • The budgeted activity was attained. Required : (i) Determine the production and sales quantities for the above year. (ii) Ascertain the effect of using a blanket rate, instead of Department-wise OH rates, on the Company’s income. (iii) Assume that material and labour costs per unit of Product X and Y were Rs. 25 and Rs. 40 respectively and the selling price is fixed by adding 40% to cover profit and selling and administration OH. Calculate the difference in the selling price due to the use of plant-wise OH rate, instead of Department-wise OH rates? (b) What is the accounting treatment for rectification costs of defective work?

Group-II : Paper-8 : Cost & Management Accounting

[ December ¯ 2011 ]

9

Answer 4. (a) (i) Computation of production and sales quantities The products processing times are as under – Product Department A Department B

X

Y

Time available

4 hours 1 hour

1 hour 4 hours

75,000 hours 75,000 hours

Let X and Y be the number of units (production quantities) of the two products. Converting these into equations, we have – 4X + Y = 75,000 & X + 4Y = 75,000 Solving the above, we get X = 15,000; Y = 15,000 Hence, the Production and Sales Quantities are determined as under – Product X Y

Production quantity 15,000 units 15,000 units

Closing stock (given) 1,500 units 4,500 units

Balance sales quantity 13,500 units 10,500 units

(ii) Effect of using plant-wise rate on the Company’s profit Product Closing stock quantity X 1,500 units Y

4,500 units

Total

Plant rate 1,500 × 5 hrs. x 1.70 = Rs. 12,750

OH included using Department rates A: 1,500 × 4 hrs. × 2.40 = Rs. 14,400 B: 1,500 x 1 hr. × 1.00 = Rs. 1,500

4,500 × 5 hrs. × 1.70 = Rs. 38,250

A: 4,500 × 1 hr. × 2.40 = Rs. 10,800 B: 4,500 × 4 hrs. × 1.00 = Rs. 18,000

(+) Rs. 9,450

= Rs. 44,700

(+) Rs. 6,300

Rs. 51,000

Difference in OH (-) Rs. 3,150

Due to the use of plant-wise overall rate, the company’s income would be affected by Rs. 6,300 Note : Profit would be affected only to the extent of OH contained in closing finished goods and closing WIP, if any. (iii) Effect of using plant-wise rate on the products’ selling prices Particulars Matls. & Labour Add: Prodn. OH

If plant-wise recovery rate is used Product X Product Y Rs. 25.00 5 × 1.70 = Rs. 8.50

Rs. 40.00 5 × 1.70 = Rs. 8.50

Cost of production Rs. 33.50 Rs. 48.50 Add : 40% of margin Rs. 13.40 Rs. 19.40 Selling price Rs. 46.90 Rs. 67.90 Effect of using plant-wise rates on product selling prices

If department –wise rates are used Product X Product Y Rs. 25.00 4 × 2.40 = Rs. 9.60 1 × 1.00 = Re. 1.00 Rs. 35.60 Rs. 14.24 Rs. 49.84 Rs. 2.94 Underpriced

Rs. 40.00 1 × 2.40 = Rs. 2.40 4 × 1.00 = Rs. 4.00 Rs. 46.40 Rs. 18.56 Rs. 64.96 Rs. 2.94 Overpriced

10

Revisionary Test Paper (Revised Syllabus-2008)

[ December ¯ 2011 ]

Answer 4. (b) The costs of rectification or re-work may be treated in the following ways – 1. When defectives are normal and inherent in the process : (i) Charged to good products – The loss is absorbed by good units. This method is used when ‘seconds’ have a normal value and defectives rectified into ‘seconds’ or ‘first’ are normal. (ii) Charged to jobs – When defectives are normal and are easily identifiable with specific jobs, the work costs are debited to the job. (iii) Charged to General overheads – When the defectives caused in one department are reflected only on further processing, the rework costs are charged to general overheads. (iv) Charged to the department overheads – If the department responsible for defectives can be identified then the rectification costs should be charged to that department. 2. When defectives are abnormal : if defectives are abnormal and are due to causes beyond the control of the firm, the rework cost should be charged to costing Profit and Loss Account. Q. 5. (a) PRIDE Ltd. manufactures and markets luxury cars in a competitive market. The Company suffered strike by production labour that lasted for two weeks. During that period, no cars produced. PRIDE issued a statement to the press that the cost of the strike was Rs. 60 crores. This was estimated on the basis of lost production of 1,000 vehicles of an average price of Rs. 6 lakhs each. PRIDE’s accountant feels that this figures, released in a hurry, overstates the cost of the strike and produces the following statement to support his views – Cost of strike Loss of revenue (1,000 cars x Rs. 6 lakhs)

Total

Rs. Lakhs 6,000

6,000

Benefits of strike Expenses avoided Materials (Rs. 1 lakh per car) Production labour (Rs. 0.5 lakh per car) Depreciation of machinery Overhead (200% of production labour) Net cost of strike (balancing figure) Total

Rs. Lakhs 1,000 500 1,750 1,000 1,750 6,000

The following additional information is available : (i) Depreciation of machines is based on the straight-line method of calculation. However, the plant manager estimates that the machines will fall in value by Rs. 250 lakhs per week regardless of the level of production. He feels that in addition its value will fall by Rs. 180 lakhs for every 100 cars that are produced. (ii) Overheads are recorded at 200% on Production Labour. This includes fixed and variable items of overheads. The General Manager estimates that Variable OH will be Rs. 15 lakhs for every 100 cars produced. (iii) During the period of the strike, the maintenance staff, whose wages are included in the fixed overhead expenses, carried out a major overhaul on some of the machines using material costing Rs. 15 lakhs. An outside contractor would perform this overhaul at a price (including materials) of Rs. 110 lakhs. (iv) The Sales Manager feels that about 40% of the production lost could be made up and sold in the next month by the production labour working overtime. Labour is paid at the rate of time and half for overtime working. You are requested to advise on the validity of both the statements and compute the true cost of the strike.

Group-II : Paper-8 : Cost & Management Accounting

11

[ December ¯ 2011 ]

(b) ABC Ltd. manufactures four variables of a product namely A,B, C & D. If the company manufactures only one variety, the monthly production can be either 5,000 of A or 10,000 of B or 15,000 of C or 30,000 of D. A Production in month Direct materials (Rs.) Direct labour (Rs.) Direct labour hours Machine hours

B

675 3,000 1,500 50 30

1,800 6,000 3,000 100 15

C

D

4,050 9,000 4,500 150 10

9,450 18,000 9,000 300 5

Required : prepare a statement showing the allocation of factory overheads (which amounted to Rs. 1,08,000) using the basis of – (i) Direct material cost (ii) Direct labour cost (iii) Prime cost (iv) Units produced (v) Direct labour hours (vi) Machine hours Answer 5. (a) Since 40% of production lost could be made up and sold in the next month, the net effect of strike is only on the permanent loss of market share i.e. balance 60%. The cost-benefit analysis is as under – Cost of strike

Rs. Lakhs

Loss of revenue (600 cars × Rs. 6 lakhs) Overtime premium for 40% balance production (400 cars × 0.5 lakhs × 50%)

Total

3,600 100

3,700

Benefits of strike

Rs. Lakhs

Expenses avoided Materials (Rs. 1 lakh × 600 cars) Production labour (Rs. 0.5 lakh x 600 cars) Depreciation (180/100 × 600) Variable OH (15/100 x 600 cars) Maintenance expenses (110 – 15) Net cost of strike (balancing figure) Total

600 300 1,080 90 95 1,535 3,700

Answer 5. (b) Statement showing the allocation of overheads Basis Direct materials cost Direct labour cost Prime cost Units produced Rs. 24, Rs. 12, Rs. 8 & Rs. 4 Direct labour hours Machine hours

Rate 300% 600% 200%

A (Rs.) 9,000 9,000 9,000

B (Rs.) 18,000 18,000 18,000

C (Rs.) 27,000 27,000 27,000

D (Rs.) 54,000 54,000 54,000

Rs. 180/ hr. Rs. 1,800/ hr.

16,200 9,000 54,000

21,600 18,000 27,000

32,400 27,000 18,000

37,800 54,000 9,000

12

Revisionary Test Paper (Revised Syllabus-2008)

[ December ¯ 2011 ]

Working notes : Calculation of overheads rate using different basis : (i)

Direct material cost : Rate =

(ii)

=

Rs. 1,08,000 × 100 Rs. 18,000

= 600%

Total Factory Overhead × 100 Total Prime Cost

=

Rs. 1,08,000 × 100 Rs. 54 ,000

= 200%

=

Rs. 1,08,000 × 100 600

= Rs. 180 per hr.

=

Rs. 1,08,000 × 100 60

= Rs. 1,800 per m/c. hr.

Total Factory Overhead × 100 Total Direct Labour hours

Machine hours : Rate =

(vi)

Total Factory Overhead × 100 Total Labour Cost

Direct labour hours : Rate =

(v)

= 300%

Prime cost : Rate =

(iv)

Rs. 1,08,000 × 100 Rs. 36,000

Direct labour cost : Rate =

(iii)

=

Total Factory Overhead × 100 Total Material Cost

Total Factory Overhead × 100 Total Machine hours

Units produced : Let us first find each unit of product in terms of D 5,000 units of A = 30,000 units of D 1 unit of A = 6 units of D Like 10,000 units of B = 30,000 units of D 1 unit of B = 3 units of D and so on Thus, overheads ratio will be 6 : 3 : 2 : 1 In term of D, the overhead expense rate will be

Rs. 1,08,000 675 × 6 + 1,800 × 3 + 4 ,050 × 2 + 9,450 × 1 Thus, rate for A will be Rs. 4 × 6 For B will be Rs. 4 × 3 For C will be Rs. 4 × 2 For D will be Rs. 4 × 1

= = = =

Rs. 24 Rs. 12 Rs. 8 Rs. 4

=

Rs. 1,08,000 27,000

=

Rs. 4

Group-II : Paper-8 : Cost & Management Accounting

[ December ¯ 2011 ]

13

Q. 6. (a) Vasudev Ltd. gives the following information : From financial records : (i) Sales for the year (ii) Direct labour (iii) Management expenses (iv) Selling expenses From inventory records : (i) Raw materials (ii) Finished goods (iii) W-I-P (50 % complete)

Rs.’000 100,00 21,00 3,00 5,00 As on 31st March 12,60 21,00 16,00

As on 1st April 10,00 19,60 12,00

From analysis of past data : (i) Direct labour would be 175% of works overheads. (ii) Cost of Goods Sold (excluding Administration Overheads) would be Rs. 13,200, per unit (iii) Selling expenses would be Rs. 1,000 per unit You are required to : (i) Compute the value of materials purchased during the year. (ii) Determine the rate of profit earned on sales. (iii) Discuss whether interest payment of Rs. 3,50,000 on working capital would affect the above rate of profit. (b) A factory department has 180 workers who are paid an average of Rs. 17.50 per week (48 hours). Dearness Allowances per month (208 hours) of Rs. 130, Provident Fund deduction is at 8% on (Basic + DA), of which 1 61 % is for Family Pension Fund of half the number of workers and Employee’s State Insurance being at Rs. 1.25 each. The employer contributing an equivalent amount. The company gives only the minimum bonus of 8 13 % and allows statutory leave of 2 weeks per year with pay. Show the weekly wage summary for the financial books and the department labour hour costs for job costing. Answer 6. (a) Cost sheet for the year ended 31st March Particulars

Computation

Rs. ’000

Opening stock of raw materials Add : Purchases & carriage inwards

(given) (balancing figure)

Less : Closing stock of raw materials Direct materials consumed Add : Direct labour PRIME COST Add : Factory overheads Add : Opening Stock of W-I-P

(given)

10,00 41,00 51,00 12,60 38,40 21,00 59,40 12,00 12,00

(given) (21,00 ÷ 175%) (given)

14

[ December ¯ 2011 ]

Revisionary Test Paper (Revised Syllabus-2008)

Less : Closing stock of W-I-P FACTORY COST / WORKS COST Add : Administration overheads (Mgmt. Exp.) COST OF PRODUCTION Add : Opening stock of finished goods COST OF GOODS AVAILABLE FOR SALE Less : Closing stock of finished goods COST OF GOODS SOLD Add : Selling and Distribution overhead COST OF SALES Add : Profit/ Loss (Balancing figure) SALES

(given) (given) (given) (given) (See note iv below) (given)

83,40 16,00 67,40 3,00 70,40 19,60 90,00 21,00 69,00 5,00 74,00 26,00 100,00

Notes : (i) The cost sheet is completed by Reverse Working. Purchases amount is the balancing figure. (ii) Direct labour = 175% of factory overhead (given). Hence, if direct labour = 21,00,000, then Factory Overhead = 21,00,000 ÷ 175% = Rs. 12,00,000 (iii) Selling OH = Rs. 1,000 p.u. = Rs. 5,00,000 (in total). So, Units sold = Rs. 5,00,000 ÷ Rs. 1,000 = 500 units. (iv) Cost of Goods Sold (excluding Administrative OH) = Rs. 13,200 p.u. Cost of Goods Sold less AOH = 13,200 p.u. × 500 units = Rs. 66,00,000 Cost of Goods Sold – Rs. 3,00,000 = Rs. 66,00,000 Hence, Cost of Goods Sold = Rs. 69,00,000 (v) Rate of profit = 26,00 ÷ 100,00 = 26% (vi) Interest on working capital shall not be considered as “Cost” since it may distort cost comparison. However, for decision-making purposes, interest is an essential element of cost and has to be included to determine relevant costs in a decision. Answer 6. (b) Weekly Wages Summary Particulars

Rs.

Wages (@ Rs. 17.50 each for 180 workers) Dearness allowance (48/208 x Rs. 130 x 180 workers)

3,150.00 5,400.00

Bonus (8 13 % of [Rs. 3,150 + Rs. 5,400]) Gross wages

712.50 9,262.50

Less : P.F. contribution (8% - 1 16 % of Rs. 8,550) 1 6

Family pension (1/2 of 1 % of Rs. 8,550) E.S.I. contribution (@ Rs. 1.25 for 180 workers) Net wages

Rs. 584 Rs. 50 Rs. 225

859.00 8,403.50

Group-II : Paper-8 : Cost & Management Accounting

[ December ¯ 2011 ]

15

Computation of Departmental Labour Cost Particulars Wages Dearness allowance Bonus P.F. contribution & family pension (Rs. 584 + Rs. 50) E.S.I. contribution Leave Pay (Rs. 8,550 x 2/52) Total labour cost Weekly labour hours (48 hours x 180 workers) Labour cost per hour (Rs. 10,450.35/8,640)

Rs. 3,150.00 5,400.00 712.50 634.00 225.00 328.85 10,450.35 8,640 hours Rs. 1.21

Q. 7. (a) Super Builder Constructions are engaged in building contracts. One of their contracts commenced 15 months ago remains unfinished. The following information relating to the contract has been prepared for the year just ended : Particulars Contract price Value of work certified at the end of the year Cost of work not yet certified at the end of year Opening balances : Cost of work completed Materials on site (physical stock) During the year : Materials delivered to site Wages Hire of plant Other expenses Closing balance : Materials on site (physical stock)

Rs. ’000 2,750 2,420 44 330 11 671 638 121 99 22

As soon as materials are delivered to the site, they are charged to the contract account. A record is also kept of materials as they are actually used on the contract. Periodically a stock check is made and any discrepancy between book stock and physical stock is transferred to a general “Contract Material Discrepancy” account. This is absorbed back to each contract, currently at the rate of 0.5% of materials booked. The stock check at the year-end revealed a stock shortage of Rs. 5,500. In addition to Direct Charges listed above, general OH are charged to contracts at 5% of value of Work certified. General OH of Rs. 16,500 had been absorbed into the cost of work completed at the beginning of the year. It has been estimated that further costs to compete the contract will be Rs. 2,42,000. This estimate included the cost of materials on site at the end of the year just finished and also a provision for rectification.

16

Revisionary Test Paper (Revised Syllabus-2008)

[ December ¯ 2011 ]

Required : (i) Determine the profitability of the above contract and recommend how much profit should be taken for the year just ended. (ii) State how your recommendation in above would be affected if the Contract Price was Rs. 44 lakhs (rather than Rs. 27.50 lakhs) and if no estimate has been made of costs to completion. Assume retention money = 20%. (b) Distinguish between job costing and process costing? Answer 7. (a) (i) Contract Account Particulars To To To To

Work-in-progress b/d Materials b/d Materials issued Wages

To Plant hire charges To Other expenses To Contract Material Discrepancy A/c – absorbed at 0.5% of (11+671-22) To General OH (5% of 2,420 – 16.50) To Notional profit c/d – balancing figure To Profit and Loss A/c – transfer To Reserve c/d – balancing figure

Rs.’000

Particulars

Rs.’000

330.00 By Work-in-progress a/c. 11.00 - Work certified 2,420.00 671.00 - Work uncertified 44.00 638.00 By Contract Material Discrepancy A/c – Shortage transfer 5.50 121.00 By Balance c/d – Materials 22.00 99.00 3.30 104.50 513.70 2,491.50 490.80 By Notional profit b/d 22.90 513.70

2,491.50 513.70 513.70

Recognition of profit : Rs. ’000 Cost incurred till date = 2,491.50 – 513.70 – 5.50 – 22.00 = 1,950.30 Estimated total costs = Costs incurred till date + Further costs to be incurred = 1,950.30 + 242.00 = 2,192.30 Estimated total profit (ETP) = Contract Price – Estimated total costs = 2,750 – 2,192.30 = 557.70 Percentage of completion = Work certified ÷ Contract price = 2,420 ÷ 2,750 = 88% Profit to be recognized = ETP x (Work certified ÷ Contract price) = 557.70 × (2,420 ÷ 2,750) = 490.80 (ii) If contract price were Rs. 44 lakhs, percentage of completion = Work certified ÷ Contract price = 55% Therefore profit recognition will be based on notional profit (since it is given that no estimate of the costs of completion has been made). Profit to be recognized = 2/3 × Notional profit × Cash received ÷ Work certified = 2/3 × 513.70 × 1,936 ÷ 2,420 = Rs. 274 lakhs.

Group-II : Paper-8 : Cost & Management Accounting

[ December ¯ 2011 ]

17

Answer 7. (b) The main points which distinguishes job costing and process costing are as below : Job Costing

Process Costing

(i) A Job is carried out or a product is produced by specific orders.

The process of producing the product has a continuous flow and the product produced is homogeneous.

(ii) Costs are determined for each job.

Costs are compiled on time basis i.e., for production of a given accounting period for each process or department.

(iii) Each job is separate and independent of other jobs.

Products lose their individual identity as they are manufactured in a continuous flow.

(iv) Each job or order has a number and costs are collected against the same job number.

The unit cost of process is an average cost for the period.

(v) Costs are computed when a job is completed. The cost of a job may be determined by adding all costs against the job.

Costs are calculated at the end of the cost period. The unit cost of a process may be computed by dividing the total cost for the period by the output of the process during that period.

(vi) As production is not continuous and each job may be different, so more managerial attention is required for effective control.

Process of production is usually standardized and is therefore, quite stable. Hence control here is comparatively easier.

Q. 8. (a) The data given related to “Opera House” a mini theatre for the year ending 31st March 2010 : No. of employees 1 10 2 4

Salaries Manager Gate-keepers Operators Clerks

Rs. 800 p.m. Rs. 200 p.m. each Rs. 400 p.m. each Rs. 250 p.m. each

Expenses Electricity and oil Carbon Misc. expenditure Advertisement Admn. Expenses Hire of point

Amount 11,655 7,235 5,425 34,710 18,000 1,40,700

The premises are valued at Rs. 6,00,000 and the estimated life is 15 years. Projectors and other equipments cost Rs. 3,20,000 on which 10% depreciation is to be charged. Daily 3 shows are run throughout the year. The total capacity is 625 seats which is divided into three classes as follows : Emerald circle 250 seats Diamond 250 seats Coral 125 seats Ascertain cost per man-shows assuming that (i) 20% of the seats remain vacant, and (ii) Weightage to be given to the three classes in the ratio 1:2:3

18

Revisionary Test Paper (Revised Syllabus-2008)

[ December ¯ 2011 ]

Required : Determine the rates for each class if the management expects 30% return on gross proceeds. Ignore entertainment taxes. (b) Explain with features of service organizations which may create problems for the application of Activity Based Costing. Answer 8. (a) Operating Cost Sheet

Rs.

Fixed costs : Salaries [800 × 12] Gate-keepers [10 × 200 × 12] Operators [2 × 400 × 12] Clerks [4 × 250 × 12] Administration expenses Depreciation : Premises [Rs. 6,00,000/15] Projections and equipment [3,20,000 × 10%] Total fixed costs Variable costs : Electricity and oil Carbon Miscellaneous expenses Advertisements Hire of point Total variable cost Total costs Add : 30% return on gross proceeds [Or 3/7 of cost] Gross proceeds Total man-shows (refer WN) Cost per man-show

9,600 24,000 9,600 12,000 18,000 40,000 32,000 1,45,200 11,655 7,235 5,425 34,710 1,40,700 1,99,725 3,44,925 1,47,825 4,92,750 9,85,500 Rs. 0.50

Rate for each class : Emerald circle cost per man-show × weightage i.e. 0.50 × 1 = Re. 0.50 Diamond circle cost per man-show × weightage i.e. 0.50 × 2 = Rs. 1.00 Coral circle cost per man-show × weightage i.e. 0.5 × 3 = Rs. 1.50 Working note : Computation of man-shows with weightage (i.e. express alls eats in terms of public) Emerald circle Diamond circle Coral circle

= = =

250 × 1 250 × 2 125 × 3

= = =

250 500 375 1,125

seats seats seats seats

Group-II : Paper-8 : Cost & Management Accounting

No. of shows : 3 Total weighted seats [1,125 × 3] Less : 20% vacant seats

[ December ¯ 2011 ]

19

= =

3,375 seats 675 seats 2,700 seats Man-shows per annum [2,700 × 365] = 9,85,500 Answer 8. (b) Service organizations predominantly have indirect costs and are hence ideal for implementation of ABC. However, the following features of service organizations create problems for application of ABC : (i) Production and consumption of many services are inseparable : Hence, the specific costs of rendering each service cannot be ascertained with reasonable accuracy. Also, difficulties are faced in apportionment of common expenses incurred over various services. (ii) Most services are intangible : This creates problems in the identification of the appropriate Cost Driver in respect of each activity/ service rendered. Sometimes, there may be two or more (equally dominant) Cost Drivers in respect of each activity. (iii) Service outputs vary from day to day : Hence, the quantity of cost driver (cost allocation base) has to be carefully determined by recording, observing and averaging out the service outputs over a considerable period of time. (iv) Pricing strategies depend on customer : The company may have different pricing strategies in respect of different customers, sometimes, which may not have any relationship with the cost incurred. Such ad-hoc pricing strategies, differential pricing strategies and price discrimination, may render the application of ABC system in fructuous. The data obtained from ABC system may not be used at all for pricing. Other problems : (v) Amount of work involved in setting up the ABC system and data collection; (vi) Lack of resources; (vii) Lack of understanding of causation effect of cost drivers; (viii) Inadequate computer software.

Q. 9. (a) The following data are available pertaining to a product after passing through two process A and B : Output transferred to Process C from Process B : 10,944 units for Rs. 59,116. Rs. Sundry materials 1,776 Direct labour 7,800 Direct expenses 1,938 The wastage of Process C is sold at Re. 1 per unit. The overhead charges were 168% of direct labour. The final product was sold at Rs. 12 per unit matching a profit of 20% on sales. Find the percentage of wastage in Process C and prepare Process C account. (b) Write a short note on unit costing method for ascertaining product cost.

20

Revisionary Test Paper (Revised Syllabus-2008)

[ December ¯ 2011 ]

Answer 9. (a) Process C Account

To To To To To To

Particulars

Units

Process B Sundry materials Direct labour Direct expenses Overheads Profit

10,944

Amount (Rs.)

59,116 1,776 7,800 1,938 13,104 20,314 10,944 1,04,048

Particulars By Normal wastage By Sales

Units

Amount (Rs.)

2,480 8,464

2,480 1,01,568

10,944

1,04,048

Working Note : Calculation of the percentage of wastage in Process C : Cost per unit = Selling price – Profit = (Rs. 12 – 0.2 × 12) = Rs. 9.60 Suppose the number of wastage = X. Then the scrap value of units in wastage = Rs. 1.00 × X = Re. X. Therefore, Total cost = (10,944 – X) units × Rs. 9.60 = Rs. 1,05,062 – Rs. 9.6X Total cost = Cost incurred – Sale value of scrap = Rs. 83,734 – Re. X Thus, 1,05,062 – 9.6X = 83,734 – X Or, 8.6X = 21,328 Or, X = 2,480 Scrap value is Rs. 1.00 per unit. Therefore, No. of units scrapped = Rs. 2,480/1 = 2,480 units Percentage of wastage in Process C = 2,480/10,944 × 100 = 22.7% Answer 9. (b) It is a form of process or operation costing. It is suitable where only one product or a few grades of the same product involving a single process or operation is produced. Under this system the expenditure is not analysed in as much detail as is necessary for job costing because the whole of the expenditure is normally incurred for only one type of product but where, however, articles produced vary in grades and sizes, it is necessary to analyse the appropriate charges for ascertaining the cost of articles. On dividing the total expenditure by the number of units produced, the cost per unit is ascertained. This system of costing is suitable for breweries, cement works etc. In all these cases, unit cost of articles produced requires to be ascertained. The cost sheets are prepared periodically and usually contain information on the under mentioned points : (i) Cost of materials consumed with details. (ii) Cost of labour with details. (iii) Indirect expenses with details. (iv) Office and administrative expenses in lumpsum. (v) Abnormal losses and gains are separated and not mixed with costs.

Group-II : Paper-8 : Cost & Management Accounting

[ December ¯ 2011 ]

21

Q. 10. (a) Following information for the month of August is extracted from the Cost records of Autoparts Ltd. which specializes in the manufacture of automobile spares. The parts are manufactured in Department A and assembled in Department B. Particulars Direct labour hours worked Machine hours worked Machine horse power (H.P.) Book value of machine (Rs.) Floor space (sq. ft.) Direct material Direct labour Factory rent Supervision Depreciation on machine Power Repairs to machine Indirect labour

Total

Dept. A

Dept. B

80,000 30,000 400 50,000 20,000 65,000 90,000 15,000 6,000 5,000 4,000 2,000 4,000

30,000 25,000 353 40,000 10,000 50,000 40,000 — 2,500 — — 1,600 2,000

50,000 5,000 47 10,000 10,000 15,000 50,000 — 3,500 — — 400 2,000

Total

Dept. A

Dept. B

3,200 7,500

2,700 3,000

500 4,500

The prime cost of batch X-401 have been booked as under : Particulars Materials Labour

Direct labour hours on batch X-401 were 2,500 in Department A and 5,000 in Department B. Machine hours worked on this batch were 1,250 in Department A and 600 in Department B. Allocate overhead expenditure and calculate the cost of each unit in batch X-401 which consists of 1,000 units. (b) What is meant by – (i) Value of work certified and (ii) Cost of work uncertified. Answer 10. (a) Statement showing allocation of overhead expenditure to Department A and B Particulars

Basis of allocation

Total

(Rs.) Department

A

B

Machine costs Depreciation Power Repairs to machine

(Plant value 4:1) (HP 353:47) (Actual)

5,000 4,000 2,000 11,000

4,000 3,530 1,600 9,130

1,000 470 400 1,870

Other overhead costs Factory rent Supervision Indirect labour

(Floor space 1:1) (Actual) (Actual)

15,000 6,000 4,000 25,000

7,500 2,500 2,000 12,000

7,500 3,500 2,000 13,000

22

Revisionary Test Paper (Revised Syllabus-2008)

[ December ¯ 2011 ]

Rs. 9,130 = Re. 0.3652; 25,000 hours

Dept. B =

Rs. 1,870 = Re. 0.374 5,000 hours

Rs. 12,000 = Re. 0.40; 30,000 hours

Dept. B =

Rs. 13,000 = Re. 0.26 50,000 hours

Machine hour rate

Dept. A =

Labour hour rate

Dept. A =

Cost sheet of Batch X-401(Batch of 1,000) Rs. Particulars Materials Labour Overheads [WN]

Hence, cost per unit in the batch =

Total 3,200 7,500 2,981 13,681

Department A B 2,700 500 3,000 4,500 1,457 1,524 7,157 6,524

Rs. 13,681 = Rs. 13.68 per unit 1,000 units

Working note : Absorption of overhead costs to batch X-401 Dept. A – Machine cost Other overhead cost

(1,250 hrs. × Re. 0.3652 per hr.) (2,500 hrs. × Re. 0.40 per hr.) Total

Rs. 457 1,000 1,457

Dept. B – Machine cost Other overhead cost

(600 hrs. × Re. 0.374 per hr.) (5,000 hrs. × Re. 0.26) Total

224 1,300 1,524

Answer 10. (b) Value of work certified : (i) As per the prevailing business practices in contract activity, the Contractor raises periodical bills on the contractee. Such bills are raised on the basis of Architect’s or Surveyor’s certificate stating the extent and value of work completed. (ii) Hence, that portion of the work which has been completed by the contractor and certified by the Architect/Surveyor is called as work certified. (iii) Value of work certified constitutes income on the contract and is credited to the contract account and debited to work in progress account (if the contract is in progress) or to contractee’s account (if the contract is completed) Cost of work uncertified : (i) It represents the cost of work, which has been carried out by the Contractor but is not certified by the Architect/ Surveyor. (ii) It constitutes the work completed from the date of the earlier certification till the end of the accounting year. The cost of work uncertified is also credited to contract account under the head “Work in Progress”.

Group-II : Paper-8 : Cost & Management Accounting

[ December ¯ 2011 ]

23

Cost of work uncertified = Total cost to date less cost of work certified less material in hand less plant at site (at WDV). Q. 11. A Company operates separate cost accounting and financial accounting systems. The following is the list of Opening balances as on 1.04.2011 in the Cost Ledger.

Stores Ledger Control Account WIP Control Account Finished Goods Control Account General Ledger Adjustment Account

Debit Rs.

Credit Rs.

53,375 1,04,595 30,780 —

— — — 1,88,750

Transactions for the quarter ended 30.06.2011 are as under : Materials purchased Materials issued to production Materials issued for factory repairs Factory wages paid (including indirect wages Rs. 23,000) Production overheads incurred Production overheads under-absorbed and written-off Sales

Rs. 26,700 40,000 900 77,500 95,200 3,200 2,56,000

The Company’s gross profit is 25% on Factory Cost. At the end of the quarter, WIP stocks increased by Rs. 7,500. Prepare the relevant Control Accounts, Costing Profit and Loss Account and General Ledger Adjustment Account to record the above transactions for the quarter ended 30.06.2011.

Answer 11. General Ledger Adjustment A/c Dr. Particulars To Sales To Balance c/d

Rs. 2,56,000 1,80,150

4,36,150

By By By By By

Particulars Balance b/d Stores ledger control A/c Wages control A/c Overheads control A/c Costing Profit & Loss A/c

Cr. Rs. 1,88,750 26,700 77,500 95,200 48,000 4,36,150

24

Revisionary Test Paper (Revised Syllabus-2008)

[ December ¯ 2011 ]

Stores Ledger Control A/c Dr. Particulars To Balance b/d To General ledger adjustment A/c

Rs. 53,375 26,700

Particulars By WIP control A/c By Factory overhead control A/c By Balance c/d

80,075

Cr. Rs. 40,000 900 39,175 80,075

WIP Control A/c Dr. To To To To

Particulars Balance b/d Stores ledger control A/c Wages control A/c Factory, O/H control A/c

Rs. 1,04,595 40,000 54,500 1,15,900 3,14,995

Particulars By Finished goods control A/c By Balance c/d

Cr. Rs. 2,02,900 1,12,095

3,14,995

Finished goods control A/c Dr. Particulars To Balance b/d To WIP control A/c

Rs. 30,780 2,02,900 2,33,680

Particulars By Cost of sales A/c (Refer to note) By Balance c/d

Cr. Rs. 2,04,800 28,880 2,33,680

Note : Gross profit is 25% of Factory cost or 20% on sales. Hence cost of sales = Rs. 2,56,000 – 20% of Rs. 2,56,000 = Rs. 2,04,800 Factory overhead control A/c Dr. Particulars To Stores ledger control A/c To Wages control A/c To General ledger adjustment A/c

Rs. 900 23,000 95,200 1,19,100

Particulars By Costing & profit loss A/c By WIP control A/c

Cr. Rs. 3,200 1,15,900 1,19,100

Cost of sales A/c Dr. Particulars To Finished goods control A/c

Rs. 2,04,800

Particulars By Costing Profit & Loss A/c

Cr. Rs. 2,04,800

Group-II : Paper-8 : Cost & Management Accounting

[ December ¯ 2011 ]

25

Sales A/c Dr. Particulars To Costing Profit & Loss A/c

Rs. 2,56,000

Cr. Rs.

Particulars By GLA A/c

2,56,000

Wages control A/c Dr. Particulars To General ledger adjustment A/c

Rs. 77,500

Cr. Rs.

Particulars By Factory overhead control A/c By WIP control A/c

77,500

23,000 54,500 77,500

Costing Profit & Loss A/c Dr. Particulars To Factory O H Control A/c To Cost of sales A/c To General ledger adjustment A/c (Profit)

Rs. 3,200 2,04,800 48,000

Cr. Rs.

Particulars By Sales A/c

2,56,000

2,56,000

2,56,000

Trial Balance (as on 30.6.2011) Particulars Stores ledger control A/c WIP control A/c Finished goods control A/c To General ledger adjustment A/c

Dr. Rs.

Cr. Rs.

39,175 1,12,095 28,880 1,80,150 1,80,150 1,80,150

26

[ December ¯ 2011 ]

Revisionary Test Paper (Revised Syllabus-2008)

Q. 12. (a) The financial books of a company reveal the following data for the year ended 31st March, 2011 : Particulars

Rs.

Opening stock : Finished goods 875 units Work-in-progress – 1.4.2010 to 31.3.2011 Raw materials consumed Direct labour Factory overheads Goodwill Administration overheads Dividend paid Bad debts Selling and distribution overheads Interest received Rent received Sales 14,500 units Closing stock : Finished goods 375 units Work-in-progress

74,375 32,000 7,80,000 4,50,000 3,00,000 1,00,000 2,95,000 85,000 12,000 61,000 45,000 18,000 20,80,000 41,250 38,667

The cost records provide as under : (i) Factory overheads are absorbed at 60% of direct wages. (ii) Administration overheads are recovered at 20% of factory cost. (iii) Selling and distribution overheads are charged at Rs. 4 per unit sold. (iv) Opening stock of finished goods is valued at Rs. 104 per unit. (v) The company values work-in-progress at factory cost for both financial and cost profit reporting. Required : (i) Prepare statements for the year ended 31st March 2011 showing : - The profit as per financial records - The profit as per costing records (ii) Present a statement reconciling the profit as per costing records with the profit as per financial records. (b) Product A passes through three processes before it is completed and transferred to the finished stock. There are no opening finished stock and no opening W-I-P. The following data are available in respect of Process 1, 2 and 3. Rs. Details Direct material Direct wages Finished stock

Process-1 1,00,000 75,000 25,000

Process – 2 25,000 50,000 32,500

Process - 3 20,000 1,00,000 47,500

Group-II : Paper-8 : Cost & Management Accounting

[ December ¯ 2011 ]

27

The output of each process is transferred to the next process or to the finished stock, as the case may be, at 20% profit on the transfer price. Sale of finished goods amounted to Rs. 5,50,000 and the stock is valued at Rs. 25,000. Prepare process accounts and finished stock account showing the profit element at each stage and also compute stock valuation for balance sheet purpose. Answer 12. (a) (i)

Profit and Loss Account of the Company (for the year ended March 31, 2011)

Dr.

Cr. Particulars

To To To To To To To To To To To

Rs.

Opening stock of finished goods Work-in-process Raw materials consumed Direct labour Factory overheads Goodwill Administration overheads Selling and distribution overheads Dividend paid Bad debts Profit

74,375 32,000 7,80,000 4,50,000 3,00,000 1,00,000 2,95,000 61,000 85,000 12,000 33,542 22,22,917

Particulars By By By By By

Sales Closing stock of finished goods Work-in-process Rent received Interest received

Rs. 20,80,000 41,250 38,667 18,000 45,000

22,22,917

Statement of Profit as per costing records (for the year ended March 31, 2011) Particulars Sales revenue (14,500 units) Cost of sales : Opening stock (875 units × Rs. 104) Add : Cost of production of 14,000 units

⎛ Rs. 17,92,000× 375 units ⎞ Less : Closing stock ⎜ ⎟ 14,000 units ⎝ ⎠ Production cost of goods sold (14,500 units) Selling and distribution overheads (14,500 units × Rs. 4) Pofit

Rs. 20,80,000 91,000 17,92,000 48,000 18,35,000 58,000 18,93,000 1,87,000

28

Revisionary Test Paper (Revised Syllabus-2008)

[ December ¯ 2011 ]

(ii)

Reconciliation Statement

Particulars

Rs.

Profit as per Cost Accounts Add : Administration OH over absorbed (Rs. 2,98,667 – Rs. 2,95,000) Opening stock overvalued (Rs. 91,000 – Rs. 74,375) Interest received Rent received Less : Factory OH under recovery (Rs. 3,00,000 – Rs. 2,70,000) Selling and distribution OH under recovery (Rs. 61,000 – Rs. 58,000) Closing stock overvalued (Rs. 48,000 – Rs. 41,250) Goodwill Dividend Bad debts Profit as per financial accounts

Rs. 1,87,000

3,667 16,625 45,000 18,000 30,000 3,000 6,750 1,00,000 85,000 12,000

83,292 2,70,292

2,36,750 33,542

Working notes : 1. No. of units produced = Sales + Cl. Stock – Opening stock = 14,500 + 375 – 875 = 14,000 2. Cost Sheet Particulars

Rs.

Raw materials consumed

7,80,000

Direct labour

4,50,000

Prime cost

12,30,000

Factory overheads (60% of direct wages) Factory cost

2,70,000 15,00,000

Add : Opening W-I-P

32,000

Less : Closing W-I-P

38,667

Factory cost of goods produced Administration overheads (20% of factory cost) Cost of production of 14,000 units

Cost of production per unit =

Total cost of production Rs. 17,92,000 = = Rs. 128 No. of units produced 14 ,000 units

14,93,333 2,98,667 17,92,000

Group-II : Paper-8 : Cost & Management Accounting

[ December ¯ 2011 ]

29

Answer 12. (b) Process – 1 Account Particulars Material Labour

Profit Balance b/d

Total (Rs.)

Cost (Rs.)

1,00,000 75,000

1,00,000 75,000

1,75,000 37,500 2,12,500 25,000

1,75,000 1,75,000 25,000

Profit (Rs.)

Particulars

- Stock c/d - Transfer to process-2 (balancing figure) 37,500 37,500 -

Total (Rs.)

Cost (Rs.)

Profit (Rs.)

25,000 25,000 1,87,500 1,50,000

37,500

2,12,500 1,75,000

37,500

Note : Profit : 20% on transfer price or 25% on cost = 25% of Rs. 1,50,000 = Rs. 37,500 Process – 2 Account Particulars

Total (Rs.)

Cost (Rs.)

Transfer from process-1 Material

1,87,500

1,50,000

25,000

25,000

Direct wages

50,000 2,62,500 57,500 3,20,000 32,500

50,000 2,25,000 2,25,000 27,857

Profit Balance c/d

Profit (Rs.)

Particulars

37,500 Stock c/d - Transfer to process-2 (balancing figure) 37,500 57,500 95,000 4,643

Total (Rs.) 32,500

Cost (Rs.) 27,857

4,643

2,87,500 1,97,143

90,357

3,20,000 2,25,000

95,000

Note : 1. Profit : 20% on transfer price or 25% on cost. = 25% on cost of units transferred to process-3 Total cost to the process Cost of end-inventory Cost of units transferred to process-3 Profit 25% of RS. 2,30,000 = Rs. 57,500

Profit (Rs.)

Rs. 2,62,500 Rs. (32,500) Rs. 2,30,000

2. Proportionate profit earned by the preceding process and included in the end-stock = (37,500/2,62,500) × Rs. 32,500 = Rs. 4,643.

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Revisionary Test Paper (Revised Syllabus-2008)

[ December ¯ 2011 ]

Process – 3 Account Particulars

Total (Rs.)

Cost (Rs.)

Transfer from process-2 Material

2,87,500

1,97,143

20,000

20,000

Direct wages

1,00,000 4,07,500 90,000 4,97,500 47,500

1,00,000 3,17,143 3,17,143 36,968

Profit Balance c/d

Profit (Rs.)

Particulars

90,357 Stock c/d - Transfer to finished stock (balancing figure) 90,357 90,000 1,80,357 10,532

Total (Rs.) 47,500

Cost (Rs.) 36,968

Profit (Rs.) 10,352

4,50,000 2,80,175 1,69,825

4,97,500 3,17,143 1,80,357

Notes : 1. Profit = 20% on transfer price or 25% on cost = 25% of (Rs. 4,07,500 – Rs. 47,500) = Rs. 90,000 2. Proportionate profit earned by the preceding process and included in the end stock = (90,357/4,07,500) × Rs. 47,500 = Rs. 10,532. Finished Stock Particulars Transfer from process-3 Profit Balance c/d

Total (Rs.)

Cost (Rs.)

Profit (Rs.)

Particulars

Total (Rs.)

Cost (Rs.)

Profit (Rs.)

4,50,000 2,80,175 1,69,825 Sales

5,50,000 2,64,609 2,58,391

1,25,000 - 1,25,000 Stock c/d 5,75,000 2,80,175 2,94,825 25,000 15,566 9,434

25,000 15,566 9,434 5,75,000 2,80,175 2,94,825

Notes : 1. Profit = Sales - Cost of sales Sales Cost of sales : Total transfer price Closing stock Profit

Rs. 5,50,000 Rs. 4,50,000 (25,000)

2. Proportionate profit earned by earlier processes and included in end stock : = (1,69,825/ 4,50,000) × Rs. 25,000 = Rs. 9,434

Rs. 4,25,000 Rs. 1,25,000

Group-II : Paper-8 : Cost & Management Accounting

[ December ¯ 2011 ]

Profit : 1. Provision for inter-process profit not yet realized will be : Process – 2 Rs. 4,643 Process – 3 Rs. 10,532 Finished stock Rs. 9,434 2. Gross profit for the year will be : Process-1 Process – 2 Provision Process – 3 Provision Finished goods Provision

31

Rs. 24,609 Rs. 37,500

Rs. 57,500 Rs. (4,643) Rs. 90,000 Rs. (10,532) Rs. 1,25,000 Rs. (9,434)

Rs. 52,857 Rs. 79,468 Rs. 1,15,566 Rs. 2,85,391

It may be noted that the figure ‘profit column’ against sales on the credit side of the finished goods accounts shows the gross profit. Stock-in-process – 1 Rs. 25,000 Stock-in-process – 2 Rs. 27,857 Stock-in-process – 3 Rs. 36,968 Finished stock Rs. 15,566 Rs. 1,05,391 Q. 13. (a) In a chemical manufacturing company, three products A, B and C emerge at a single split off stage in department P. Product A is further processed in department Q, product B in department R and product R and product C in department S. There is no loss in further Processing of any of the three products. The cost data for a month are as under : Cost of raw materials introduced in department P Rs. 12,68,800 Direct Wages Department Rs. P 3,84,000 Q 96,000 R 64,000 S 36,000 Factory overheads of Rs 4,64,000 are to be apportioned to the departments on direct wage basis. During the month under reference, the company sold all three products after processing them further as under : Products A B C Output sold kg. 44,000 40,000 20,000 Selling Price per kg. Rs. 32 24 16 There are no Opening or Closing Stocks If these products were sold at the split off stage, that is, without further processing, the selling prices would have been Rs. 20, Rs. 22 and Rs. 10 each per kg respectively for A, B and C.

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Revisionary Test Paper (Revised Syllabus-2008)

Required: (i) Prepare a statement showing the apportionment of joint costs to joint products: (ii) Present a statement showing product-wise and total profit for the month under reference as per the company’s current processing policy. (iii) What processing decision should have been taken to improve the profitability of the company. (iv) Calculate the product-wise and total profit arising from your recommendation in (iii) above. (b) Distinguish between Indifference Point and Break-Even Point. Answer 13. (a) (i)

Statement showing the apportionment of joint costs to joint products Products A B C Output sold Kgs.: (I) 44,000 40,000 20,000 Selling price per kg. at split off (Rs.) : (II) 20 22 10 Sales value at split off (Rs.): (I) × (II) 8,80,000 8,80,000 2,00,000 Joint costs (costs incurred in department P (Rs.) 8,80,000 8,80,000 2,00,000 (apportioned on the basis of sales value at the point of split off) i.e. (22:22:5) (ii)

Total

19,60,000 19,60,000

Statement showing product-wise and total profit for the month under reference (as per the company’s current processing policy) Products

A Output Kgs. : (a) 44,000 Selling price per kg. after further processing (Rs.): (b) 32 Sales value after further processing (Rs). : (c) = {(a) × (b)} 14,08,000 Joint costs (Rs.): (d) 8,80,000 (Refer to b (i) working notes & 2(i) Further processing costs (Rs.): (e) 1,72,800 (Refer to working note 2 (ii) Total costs (Rs.) : (f) = [(d) + (e)} 10,52,800 Profit/ (Loss) (Rs.) : [(c))– (f)} 3,55,200

B 40,000 24

C 20,000 16

Total

9,60,000 8,80,000

3,20,000 2,00,000

26,88,000 19,60,000

1,15,200

64,800

3,52,800

9,95,200 (35,200)

2,64,800 55,200

23,12,800 3,75,200

Alternatively : Incremental sales revenue (Rs.)

5,28,000 80,000 1,20,000 (44,000 units × Rs. 12) (40,000 units × Rs. 2) (20,000 units × Rs. 6) Less: Further processing costs (Rs.): 1,72,800 1,15,200 64,800 [Refer to working note 2 (ii)] Incremental net profit / (loss) 3,55,200 (35,200) 55,200

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33

(ii) Processing decision to improve the profitability of the company. 44,000 units of product A and 20,000 units of product C should be further processed because the incremental sales revenue generated after further processing is more than the further processing costs incurred. 40,000 units of product B should be sold at the point of-split off because the incremental revenue generated after further processing is less than the further processing costs. (iv) The product wise and total profit arising from the recommendation in (iii) above is as follows : Product

A

Profit (Rs.)

3,55,200

B

C

Total



55,200

4,10,000

Q Rs.

R Rs.

Working notes : 1.

Statement of department-wise costs

Raw materials Wages Overheads (Apportioned on the basis of departmental direct wages i.e. 96:24:16:9) Total Cost

P Rs. 12,68,800 3,84,000 3,07,200

19,60,000

– 96,000 76,800

S Rs.

– 64,000 51,200

– 36,000 28,800

1,72,800 1,15,200

64,800

2. Joint costs and further processing costs (i) Costs incurred in the department P are joint costs of products A, B and C and are equal to Rs. 19,60,000. (ii) Costs incurred in the departments Q, R and S are further processing costs of products A, B and C respectively. Further processing costs of products A, B and C thus are Rs. 1,72, 800; Rs. 1,15,200 and Rs. 64,800 respectively. Answer 13. (b) Particulars

Indifference Point

Break-Even Point

Definition

Indifference Point is the level of Sales at BEP is the level of sales at which there is which Total costs and Profits of two neither a Profit nor a Loss to the firm. At BEP, options are equal. the total Contribution equals Fixed Cost.

Formula

Indifference Point (in Rs. ) = Difference in Fixed Cost Difference in Var. Cost ratio or PV ratio

Significance It is the activity level at which Total Cost under two alternatives are equal. Purpose

Break Even Point (in Rs.) = Fixed Cost PV ratio

It is the activity level at which the Total Revenue from a product mix is equal to its Total cost.

Used to choose between two alternative Used for profit planning. options for achieving the same objective.

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Revisionary Test Paper (Revised Syllabus-2008)

Q. 14. (a) ABC Ltd. produces four products in its factory. The volume of production and sales achievement in considerably lower than normal and so there has been substantial under-recovery of overheads. The sales and cost particulars are as under :

Rs. In lakhs

Particulars Sales Costs : Direct materials Direct wages Factory overheads Selling and Admin. Expenses (15% of sales) Profit/ (Loss) Under-recovery of overheads Profit before tax

Products A 160 24 40 48 24 136 24

B 200 32 48 64 30 174 26

C 80 16 32 40 12 100 (20)

Total D 40 3 8 8 6 25 15

480 75 128 160 72 435 45 24 21

40% of factory overheads is variable at normal volume and the selling and admin. Overheads are variable to the extent of 5% of sales. 20% of sales of Product C is done in conjunction with Product A in as much as the discontinuance of Product C will bring down the sales of Product A by 10%. Alternatively, the sales of Product C can be reduced to 20% of the present level to maintain the sales of Product A. In view of the loss reported for Product C, the management has for consideration three proposals, viz : (i) Discontinue Product C. In that event the company can save a sum of Rs. 8 lakhs per annum in fixed expenses. (ii) Maintain the sales of Product C to the extent of 20% of the present sales as service to Product A. In that event the reduction of fixed expenses will be Rs. 3 lakhs. (iii) Discontinue Product C totally and increase the sales of Product D for which demand is available to the extent of Rs. 40 lakhs. This can be done without any change in fixed expenses. Show the financial implications of the aforesaid three proposals as compared with the annual operating results generating a profit before tax of Rs. 21 lakhs. Suggest a course of action to be followed by the management. (b) Fixed Costs are irrelevant for decision-making. What are the exceptions?

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35

Answer 14. (a) Comparative Profitability Statement Rs. In lakhs Products A Sales Less : Variable costs Direct Matl. 24 Direct wages 40 V. Factory OH 22.08* V. Sale + Admn. OH 8 Contribution Less : Fixed costs Factory OH 33.12 Sales + Admn. OH 16 Profit / Loss

B 160

200

32 48 29.44 94.08 10 65.92

49.12 16.80

C

44.16 20

16 32 18.40 119.24 4 80.56

64.16 16.40

27.60 8

D

Total

80

40

480

70.40 9.60

3 8 3.68 2 16.68 23.32

75 128 73.60 24 300.60 179.40

35.60 (26.00)

5.52 4

9.52 13.80

110.40 48 158.40 21.00

* Calculation of factory Overhead : Rs. In lakhs Charged to products 160 Add : Under-recovery of overheads 24 Total factory overhead 184 Under recovery accounts for only 15%. Now the apportionment will be on the basis of variable 40% and fixed 60%, as : Rs. In lakhs A B C D Total Factory overhead 48.00 64.00 40.00 8.00 160.00 Add : 15% for under-recovery 7.20 9.60 6.00 1.20 24.00 55.20 73.60 46.00 9.20 184.00 Variable 40% 22.08 29.44 18.40 3.68 73.60 Fixed 60% 33.12 44.16 27.60 5.52 110.40 Alternative Proposals : (i) If product C is eliminated : If product C is discontinued, no doubt there will be a saving in fixed cost of Rs. 8 lakhs but, at the same time, sale of Product A will go down by 10%. Thus the result will be : Contribution from : Rs. In lakhs A (Rs. 65.92 lakhs less 10%) 59.328 B 80.560 23.320 D Total 163.208 Less : Fixed cost (Rs. 158.40 – Rs. 8 lakhs) 150.400 12.808 Profit

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(ii)

If Product C is sold only to the extent of 20% :

Revisionary Test Paper (Revised Syllabus-2008)

Contribution from : A B C (only 20% of 9.60) D

Rs. In lakhs 65.920 80.560 1.920 23.320

Total

171.720

Less : Fixed cost (Rs. 158.40 – Rs. 3 lakhs)

155.400

Profit

16.320

(iii) If Product C is totally discontinued and the Product D increased at Rs. 80 lakhs; Contribution from :

Rs. In lakhs

A (Rs. 65.92 lakhs less 10%)

59.328

B

80.560

D (23.32 × 2)

46.640

Total

186.528

Less : Fixed cost (Rs. 158.40 – Rs. 8 lakhs)

150.400

Profit

36.128

Recommendation : Out of the three proposals, proposal (iii) (i.e., to eliminate Product C) may be accepted since it produces the highest profit. Other two proposals do not produce successful consideration. As such, they should be avoided. Answer 14. (b) Fixed costs are unrelated to output and are generally irrelevant for decision-making purpose. However, in the following circumstances, Fixed Costs become relevant for decision-making(i) When fixed costs are specifically incurred for any contract. (ii) When fixed costs are incremental in nature. (iii) When the fixed portion of semi-variable cost increases due to change in level of activity consequent to acceptance of a contract. (iv) When fixed costs are avoidable or discretionary. (v) When fixed costs are such that one cost is incurred in lieu of another (the difference in costs will be relevant for decision-making).

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37

Q. 15. (a) Genious Ltd. manufactures two parts ‘A’ and “B” for Computer Industry. A : Annual production and sales of 1,00,000 units of a selling price of Rs. 100.05 per unit. B : Annual production and sales of 50,000 units at a selling price of Rs. 150 per unit. Direct and Indirect costs incurred on these two parts are as follows : Rs. in thousands Particulars A B Total Direct material cost (variable) 4,200 3,000 7,200 Labour cost (variable) 1,500 1,000 2,500 Direct machining cost (see note) 700 550 1,250 Indirect cost : Machine set up cost 462 Testing cost 2,375 Engineering cost 2,250 16,037 Note : Direct machining costs represent the cost of machine capacity dedicated to the production of each product. These costs are fixed and are not expected to vary over the long-run horizon. Additional information is as follows : Particulars Production batch size Set up time per batch Testing time per unit Engineering cost incurred on each product

A 1,000 units 30 hours 5 hours 8.40 lakhs

B 500 units 36 hours 9 hours 14.10 lakhs

A foreign competitor has introduced product very similar to ‘A’. To maintain the company’s share and profit, Genious Ltd. has to reduce the price to Rs. 86.52. The Company calls for a meeting and comes up with a proposal to change design of Product ‘A’. The expected effect of new design is as follows : (i) Direct material cost is expected to decrease by Rs. 5 per unit (ii) Labour cost is expected to decrease by Rs. 2 per unit (iii) Machine time is expected to decrease by 15 minutes; previously it took 3 hrs. to produce 1 unit of ‘A’. The machine will be dedicated to the production of new design. (iv) Set up time will be 28 hrs. for each set up. (v) Time required for testing each unit will be reduced by 1 hr. (vi) Engineering cost and batch size will be unchanged Required : (i) Company management identifies that cost driver for Machine set-up cost is ‘set up hrs. used in batch setting’ and for testing costs is ‘testing time’. Engineering costs are assigned to products by special study. Calculate full cost per unit for ‘A’ and ‘B’ using Activity Based Costing. (ii) What is the mark-up on full cost per unit of A?

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Revisionary Test Paper (Revised Syllabus-2008)

[ December ¯ 2011 ]

(iii) What is the Target cost per unit for new design to maintain the same mark up percentage on full cost per unit as it had earlier? Assume cost per unit of cost drivers for the new design remains unchanged. (iv) Will the new design achieve the cost reduction target? (v) List four possible management actions that the Genious Ltd. should take regarding new design. (b) What is differential costing?

Answer 15. (a) (i)

Computation of full cost per unit using Activity Based Costing :

Particulars Direct material Direct labour Direct machine cost Machine set up cost Testing cost Engineering cost Total cost (Rs.) Cost per unit (Rs.) (ii)

Basis

A

B

Direct Direct Direct 3,000 hrs. @ Rs. 70 3,600 hrs. @ Rs. 70 5,00,000 hrs. @ Rs. 2.50 4,50,000 hrs. @ Rs. 2.50 Allocated

42,00,000 15,00,000 7,00,000 2,10,000

30,00,000 10,00,000 5,50,000 2,52,000

12,50,000 8,40,000 87,00,000 87.00

Mark up in full cost basis for Product A :

Particulars

Per unit (Rs.)

Selling price Less : Full cost Mark up

100.05 87.00 13.05

13.05 Percentage of mark up on full cost = 87.00 × 10

(iii)

11,25,000 14,10,000 73,37,000 146.74

15%

Target cost of Product A after new design is implemented

Particulars Target price (given) Mark-up [86.25 × 15/115] Target cost per unit (Rs.)

Rs. 86.25 11.25 75.00

Group-II : Paper-8 : Cost & Management Accounting

(iv)

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Statement of cost for new design of A : Particulars

Direct material Direct labour Direct machine cost Machine set up cost Testing cost Engineering cost

Basis Decreased by Rs. 5 p.u. Decreased by Rs. 2 p.u. No change as machine is dedicated 100 set up × 28 hrs. × Rs. 70 1,00,000 units × Rs. 2.5 × 4 hours No change

Total cost (Rs.)

Cost per unit

Total cost

37.00 13.00 7.00 1.96 10.00 8.40

37,00,000 13,00,000 7,00,000 1,96,000 10,00,000 8,40,000

77.36

77,36,000

The target cost is Rs. 75 p.u. and estimated cost of new design is Rs. 77.36 p.u.. The new design does not achieve the target cost set by Genious Ltd. Hence the target mark up shall not be achieved. (v) Possible management action : 1. Value engineering and value analysis to reduce the direct material cost. 2. Time and motion study in order to redefine the direct labour time and related costs. 3. Exploring possibility of cost reduction in direct machining cost by using appropriate techniques. 4. Identification of non-value added activities and eliminating them in order to reduce overheads. 5. The expected selling price based on estimated cost of Rs. 77.36 p.u. is (Rs. 77.36 + 15%) Rs. 88.96. Introduce sensitivity analysis after implementation of new design to study the sales quantity changes in the price range of Rs. 86.25 to Rs. 88.96. Working notes : Particulars Production / sales quantity (units) Batch size (units) No. of batches Set up time per batch (hrs.) Total set up hrs. (hrs.) Machine set up cost (Rs.) Cost driver per machine set up hr. [4,62,000/6,600] Testing time per unit Total testing time (hrs.)

Cost driver per testing hour =

A

B

1,00,000 1,000 100 30 3,000 4,62,000 Rs. 70 5 hrs. 5,00,000

50,000 500 100 36 3,600 4,62,000 Rs. 70 9 hrs. 4,50,000

Total Testing Cost Rs. 23,75,000 = = Rs. 2.50 per hr. Total Testing Time 5,00,000 + 4,50,000

Answer 15. (b) Differential costing is a technique of decision-making in which differential costs of various alternatives are compared with the differential revenues for the purposes of choosing between competing alternatives. So long as the incremental revenues exceed incremental costs, the decision should be in favour of the

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[ December ¯ 2011 ]

Revisionary Test Paper (Revised Syllabus-2008)

proposal. It is the net increase or decrease in total cost which results from any variation in level of operations. It includes both fixed and variable costs. It is termed as incremental cost when the cost increases and as decremental cost when the cost decreases. Differential cost differs from the Marginal Cost in the sense that Marginal Cost includes the material, labour, direct expenses and variable overheads whereas Differential Cost includes both fixed and variable costs. Some of the areas in which differential cost techniques is used are – whether to process further or not, whether to accept an additional order at lower than existing price. Q. 16. (a) Jupiter Ltd. assembles bicycles. This year’s expected production is 10,000 units. Jupiter makes the chains for its bicycles. Its accountant reports the following costs for making 10,000 bicycles chains – Particulars

Costs per unit (Rs.)

Direct materials Direct manufacturing labour Power and utilities (variable) Inspection, set-up and materials handling Machine rent Allocated fixed costs of plant administration, insurance etc. Total Costs

4.00 2.00 1.50

Total for 10,000 units (Rs.) 40,000 20,000 15,000 2,000 3,000 30,000 1,10,000

Jupiter received an offer from an outside vendor for the supply of any number of chains at Rs. 8.20 per chain. The following additional information is available on Jupiter’s operations – (i) Inspection, set-up and materials handling costs vary with the number of batches in which the chains are produced. Jupiter currently produces the chains in batches of 1,000 units. It estimates that 10 batches are required for meeting the expected production requirements. (ii) Jupiter pays the rent for the machine used to make the chains. If it chooses to outsource the chains, machine rent can be avoided. Required : (i) Should Jupiter accept the vendor’s offer for 10,000 units? What is the net gain/ (loss)? What is the maximum price payable to the vendor? (ii) Suppose the chains were purchased outside, the facilities where the chains are currently made will be used to upgrade the bicycles by adding mud flaps and reflectors. As a result, the selling price of the bicycles can be increased marginally by Rs. 20. The variable costs of the upgrade would be Rs. 18 and additional tooling costs of Rs. 16,000 would be incurred. Should Jupiter make or buy the chains, at the anticipated production level of 10,000 units ? What is the maximum price payable to the vendor in this situation? (iii) Jupiter’s Sales Manager is concerned that the estimate of 10,000 units may be high and believes that only 6,200 units can be sold. Production will be cut back, freeing up work facilities and space. This space can be used to add the mud flaps and reflectors whether Jupiter outsources the chains or makes them in-house. At this lower output, Jupiter will produce the chains in 8 batches of 775 units each. Should Jupiter purchase the chains from the outside vendor? Show your calculations.

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41

(b) What will be the basis of transfer pricing, if unit variable cost and unit selling price are not constant? Answer 16. (a) (i)

Computation of Relevant costs of own production

Particulars Direct materials Direct manufacturing labour Power and utilities Inspection, set-up etc. Machine rent Fixed costs -

-

Nature and computation Variable and relevant – Rs. 4 × 10,000 units Variable and relevant – Rs. 2 × 10,000 units Variable and relevant – Rs. 1.50 × 10,000 units Batch related production costs – specific – given Specifically incurred – relevant Allocated and irrelevant Total relevant costs for own production

Rs. 40,000 20,000 15,000 2,000 3,000 Nil 80,000

Average cost per unit for own production = Rs. 80,000 ÷ 10,000 units = Rs. 8 per unit Since cost of buy is Rs. 8.20 per unit, there is an incremental cost of Rs. 8.20 – Rs. 8.00 = Re. 0.20 per unit or Rs. 2,000 in total, in case of purchase. Hence, the company should not accept the vendor’s offer. Maximum price payable = Relevant Cost = Rs. 8.00 per unit.

(ii) Alternative use of facilities : -

Additional benefit from upgradation = 10,000 units × (Rs. 20 – Rs. 18) = Rs. 20,000 Less : Fixed costs incurred specifically = Rs. 16,000 Net additional benefit = Rs. 4,000

-

Since this benefit will be foregone due to own production of chains, the relevant cost of own production will then be Rs. 80,000 (as already computed) + Rs. 4,000 (opportunity cost ) = Rs. 84,000 Average relevant cost per unit for own production = Rs. 84,000 ÷ 10,000 units = Rs. 8.40 per unit Since cost of buy is Rs. 8.20 per unit, there is a saving of Rs.8.40 – Rs. 8.20 = Re. 0.20 per unit or Rs. 2,000 Maximum price payable = Relevant cost = Rs. 8.40 per unit

-

(iii) Revision in Production Estimates – Computation of Relevant Costs of own production : Particulars Direct materials Direct manufacturing labour Power and utilities Inspection, set-up etc. Machine rent Fixed costs

Nature and computation

Rs.

Variable and relevant – Rs. 4 × 6,200 units Variable and relevant – Rs. 2 × 6,200 units Variable and relevant – Rs. 1.50 × 6,200 units Batch related costs – (Rs. 2,000 ÷ 10 batches) × 8 batches Specifically incurred – relevant Allocated and irrelevant

24,800 12,400 9,300 1,600 3,000 Nil

Total relevant costs for own production

51,100

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Revisionary Test Paper (Revised Syllabus-2008)

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Average cost per unit for own production = Rs. 51,100 ÷ 6,200 units = Rs. 8.24 per unit Since cost of buy is Rs. 8.20 per unit, there is a saving of Rs. 8.24 – Rs. 8.20 = Re. 0.04 per unit or Rs. 248 in total, in case of purchase. Hence, the company should purchase the chains from the Vendor. Maximum price payable = Relevant Cost = Rs. 8.24 per unit.

Answer 16. (b) If variable cost per unit and Selling price per unit are not constant, the Transfer Prices should be determined in the following manner – (i) Optimum level for company : There would be an optimum level of output for a firm as a whole. This is so because there is a certain level of output beyond which its net revenue will not rise. The ideal Transfer Price under these circumstances will be that which will motivate these managers to produce at this level of output. (ii) Decision from company viewpoint : In certain cases, some departments of the firm might have to produce its output at a level less than its full capacity. In such cases, a Transfer Price may be imposed centrally, considering overall company profitability and sub-ordination of divisional to organizational interest. Q. 17. (a) Compact Ltd. drew up its budget for the year, segregating costs into fixed and variable costs. The direct material cost has been determined at Rs. 80 per unit of product manufactured; direct labour, Rs. 50 per unit’ variable overhead, Rs. 20 per unit and fixed overhead, Rs. 60,00,000. Administration and selling expenses will have a fixed component of Rs. 20,00,000 and a variable component of Rs. 30 per unit sold. A selling price of Rs. 500 per unit, a sales volume of 30,000 units was expected and the budget for the period was drawn up as below : Budgeted Income statement (Absorption costing) Particulars Sales (30,000 units at Rs. 500) Cost of goods sold : Opening stock Direct materials Direct labour Variable overhead Fixed overhead Closing stock Gross profit Fixed selling and administration OH Variable selling and administration OH Net profit

Rs.

Rs. 1,50,00,000

24,00,000 15,00,000 6,00,000 60,00,000 20,00,000 9,00,000

1,05,00,000 45,00,000 29,00,000 16,00,000

The actual production for the year was 30,000 units, as budgeted. But only 20,000 units could be sold at Rs. 500 per unit. Another 3,000 units were sold to a foreign distributor at Rs. 300 per unit. The actual results for the year are presented below :

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Actual Income Statement (Absorption Costing) Particulars Sales (20,000 units at Rs. 500 + 3,000 units at Rs. 300) Cost of goods sold : Opening stock Direct materials Direct labour Variable overhead Fixed overhead Cost of goods available Less : Closing stock Gross profit Fixed selling and administration OH Variable selling and administration OH Net profit

Rs.

Rs. 1,09,00,000

24,00,000 15,00,000 6,00,000 60,00,000 1,05,00,000 24,50,000*

80,50,000 28,50,000

20,00,000 6,90,000

26,90,000 1,60,000

*Closing stock consists of 7,000 units at Rs. 350 each = Rs. 24,50,000 Cost of goods manufactured ÷ Units manufactured = 105,00,000 ÷ 30,000 = Rs. 350 The Managing Director of Compact Ltd. was critical of the sale of 3,000 units to the foreign distributor at below cost. With a manufacturing cost of Rs. 350 per unit and variable selling cost of Rs. 30 per unit he felt that on the 3,000 units the company lost Rs. 2,40,000. Had it not been for this, he felt that the profit should have been Rs. 4,00,000 as against Rs. 1,60,000 reported. He was very much at what he considered to be the blunder of this special sale. You have to explain to him the correct financial position. (i) Prepare the absorption cost income statement assuming the company sold only 20,000 units at Rs. 500 and had not done the sale to the foreign distributor. (ii) Prepare a direct cost income statement based on actual sales and reconcile it to the actual absorption cost income statement. (iii) Prepare a direct cost income statement assuming sale of only 20,000 units at Rs. 500 and reconcile this with the comparative absorption cost income statement. (iv) Is Compact Ltd. better or worse off for having made the foreign sale. (b) What are the rules for determining the relevant cost of materials, for a specific contract? Answer 17. (a) Absorption Cost – Income Statement (Assuming company sold only 20,000 units with no sale to foreign distributor) Particulars Sales (20,000 units at Rs. 500) Cost of goods sold : Opening stock Direct materials

Rs.

Rs. 1,00,00,000

— 24,00,000

44

Revisionary Test Paper (Revised Syllabus-2008)

[ December ¯ 2011 ]

Direct labour Variable overhead Fixed overhead Cost of goods produced Less : Closing stock (10,000 units x 350) Gross profit Fixed selling and administration OH Variable selling and administration OH Net profit

15,00,000 6,00,000 60,00,000 1,05,00,000 35,00,000 20,00,000 6,00,000

70,00,000 30,00,000 26,00,000 4,00,000

The working supports the statement of Managing Director that profit under absorption cost basis will be higher, if foreign sale is not undertaken.

(ii)

Direct Cost Income Statement :

Particulars Sales (20,000 units at Rs. 500 + 3,000 units at Rs. 300) Variable Cost of goods sold : Direct materials Direct labour Variable overhead Cost of goods produced Less : Closing stock (7,000 units × 150*) Variable selling and administration OH (23,000 × Rs. 30) Contribution Less : Fixed Cost : Production OH Selling & Admn. OH Net loss Reconciliation : Net profit as per Absorption Costing Less : Fixed cost relating to closing stock charged to P&L A/c. for this year : 7,000 × (Rs. 350 – Rs. 150) Net loss *Rs. 45,00,000 ÷ 30,000 = Rs. 150 per unit

Rs.

Rs. 1,09,00,000

24,00,000 15,00,000 6,00,000 45,00,000 10,50,000

60,00,000 20,00,000

34,50,000 74,50,000 6,90,000 67,60,000

80,00,000 12,40,000 1,60,000 14,00,000 12,40,000

Group-II : Paper-8 : Cost & Management Accounting

(iii)

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45

Direct Cost Income Statement (Assuming that there is sale of only 20,000 units)

Particulars

Rs.

Sales (20,000 units at Rs. 500) Less : Variable Cost of goods sold : Direct materials Direct labour Variable overhead Variable Cost of goods produced Less : Closing stock*

Rs. 1,00,00,000

24,00,000 15,00,000 6,00,000 45,00,000 15,00,000

Less : Variable selling and administration OH (20,000 × Rs. 30) Less : Fixed Cost : Production OH Selling & Admn. OH Net loss Reconciliation : Net profit as per Absorption Costing Less : Fixed OH relating to closing stock i.e. 10,000 × (Rs. 350 – Rs. 150) Net loss as per Direct Costing

60,00,000 20,00,000

30,00,000 70,00,000 6,00,000 64,00,000

80,00,000 16,00,000 4,00,000 20,00,000 16,00,000

*10,000 units × (45,00,000 ÷ 30,000 units) (iv) Absorption Costing Income Statement leads to the conclusion that sale to foreign distributor was not a good deal. Based on Direct Cost Income Statement it becomes clear that sale to foreign distributor brings down the loss to Rs. 12,40,000 from Rs. 16,00,000 when there was no sale. Direct Costing Statement gives a better reflection of company’s financial position. Answer 17. (b) Situation 1. Material already available or ordered (i) Regularly used (ii) Rarely used 2. Materials to be purchased

Relevant Cost Current replacement cost is relevant as incremental cost Net realizable value is relevant as Opportunity cost Purchase price being out-of-pocket cost is relevant

46

Revisionary Test Paper (Revised Syllabus-2008)

[ December ¯ 2011 ]

Q. 18. (a) Fastners Ltd. is having production shops reckoned as cost centres. Each shop charges other shops for material supplied and services rendered. The shops are motivated through goal congruence, autonomy and management efforts. Fastners Ltd. is having a welding shop and painting shop. The welding shop welds annually 75,000 purchased items with other 1,50,000 shop-made parts into 12,000 assemblies. The assemblies are having total cost of Rs. 9.50 each and are sold in market at Rs. 12 per assembly. Out of the total production, 80% is diverted to painting shop at the same price ruling in the market. Welding shop incurs a fixed cost of Rs. 25,000 per annum. The painting shop is having fixed costs of Rs. 30,000 and its cost of painting including transfer price from welding shop comes to Rs. 20 per unit. This shop sells all units transferred to it by welding shop at Rs. 25 per assembly. You are required to : (i) Find out profit of individual cost centre and overall profitability of the concern (ii) Recommended course of action if painting shop wishes to purchase its full requirement (at market price which is Rs. 10 per assembly) either from open market or from welding shop at market price of Rs. 10 per assembly. Give reasons for your recommendations. (b) Discuss the role of cost in Product Mix Decisions. Answer 18. (a) Fastner Ltd. Present profitability of individual shops and overall profitability Particulars

Sale in open market Transfer to paint shop Total sales Less : Variable cost (12,000 × 9.50) (9,600 × 20) Contribution Less : Fixed cost Profit

Welding shop

Painting shop

Qty. (units)

Rate (Rs.)

Value (Rs.)

Qty. (units)

Rate (Rs.)

Value (Rs.)

2,400 9,600 12,000

12.00 12.00

28,800 1,15,200 1,44,000 1,14,000 30,000 25,000 5,000

9,600

25.00

2,40,000

9,600

2,40,000 1,92,000 48,000 30,000 18,000

Overall profit for the company (5,000 + 18,000) = Rs. 23,000. When painting shop purchases all its requirement from open market at a price of Rs. 10 per unit : Particulars

Sales Less : Variable cost Contribution Less : Fixed cost Profit/ (Loss)

Welding shop Qty. Rate Value (units) (Rs.) (Rs.) 2,400 2,400

12.00 9.50

28,800 22,800 6,000 25,000 (19,000)

Overall profit for the company = Rs. (37,200 – 19,000) = Rs. 18,200

Painting shop Qty. Rate Value (units) (Rs.) (Rs.) 9,600 25.00 9,600 18.00*

2,40,000 1,72,800 67,200 30,000 37,200

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* It is given in the question that cost of painting including transfer price from welding shop is Rs. 20 per unit. The transfer price from welding shop is Rs. 12 per unit. Therefore, the variable cost of Rs. 8 (Rs. 20 – 12) is incurred by painting shop exclusively. The painting shop will be purchasing its requirement from open market at Rs. 10 per unit. Therefore, the variable cost per unit in painting shop will be Rs. 18 (Rs. 10 + 8). This point should be noted carefully. When all the requirement of painting shops is met by transfer from welding shop at a transfer price of Rs. 10 per unit. Particulars

Sales in the open market Transfer to paint shop Total sales Less : Variable cost Contribution Less : Fixed cost Profit/ (Loss)

Welding shop

Painting shop

Qty. (units)

Rate (Rs.)

Value (Rs.)

Qty. (units)

Rate (Rs.)

Value (Rs.)

2,400 9,600 12,000

12.00 10.00

28,800 96,000 1,24,800 1,14,000 10,800 25,000 (14,200)

9,600

25.00

2,40,000

9.50

9,600 18

2,40,000 1,72,800 67,200 30,000 37,200

Overall profit of the company = Rs. (37,200 – 14,200) = Rs. 23,000 For the purpose of comparison, the results of the three alternatives are summarized below : Particulars Profit under present situation Profit /(loss) under option (i) Profit /(Loss) under option (ii)

Welding shop

Painting shop

Overall profit

5,000 (19,000) (14,200)

18,000 37,200 37,200

23,000 18,200 23,000

The discussion is confined to either option (i) or (ii) Alternative (ii) should be accepted due to the following reasons : (i) It gives a maximum overall profit of Rs. 23,000 (ii) Each shop is treated as a separate cost centre and not a profit centre. (iii) The policy of overall goal congruence of the company is followed. Answer 18. (b) The role of cost in Product Mix Decision are as follows : (i) In product mix decision based on available resources and facilities, the end results should always aim at profit maximization. For this purpose, costs, to be relevant, should meet the following criteria – 1. The costs should be expected as Future Costs. 2. The costs differ among the alternative courses of action i.e. Differential cost. (ii) Variable costs are relevant costs in product mix decisions and consequently Contribution (PV Ratio) plays a major role in profit maximization.

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Revisionary Test Paper (Revised Syllabus-2008)

[ December ¯ 2011 ]

(iii) In addition to relevancy of costs, the other factors that should be considered in deciding the product mix are – 1. Available Production Capacity and Limiting Factors, if any. 2. Contribution per unit of the Limiting Factor. 3. Market Demand for the products. 4. Opportunity Costs, if any.

Q. 19. (a) ABC Ltd. provides you the following information : (i) Sales, Purchases etc. Particulars Cash sales Collection from debtors Cash purchases Payment to creditors Payment of expenses

April 8,000 16,000 8,000 12,000 12,000

Amt. in Rs.

May 12,000 32,000 12,000 24,000 5,000

June 16,000 48,000 16,000 36,000 7,800

July 20,000 64,000 20,000 48,000 2,950

Aug 24,000 80,000 24,000 60,000 27,000

Sept. 28,000 96,000 28,000 72,000 20,000

(ii) The opening cash balance of Rs. 10,000 is the minimum cash balance to be maintained. (iii) Any short fall in the minimum cash balance is to be met by Bank borrowings in the multiple of Rs. 5,000 @ 12% p.a. or by sale of marketable securities in the multiple of Rs. 10,000. Bank interest on monthly basis is payable on the first date of the subsequent month. Bank interest is payable for a minimum period of a month. (iv) Any surplus cash is to be used to repay the borrowings in the multiple of Rs. 5,000 or to purchase the marketable securities in the multiple of Rs. 10,000 (ignore interest on securities received and paid). Required : Prepare the Cash Budget for April to September. (b) Define zero base budgeting and distinguish it from traditional budgeting. Answer 19. (a) Cash Budget for April to September Particulars A. Total Cash available : Opening cash balance Cash sales Collection from debtors B. Total Cash Payments : Cash purchases Payment to creditors Payment of expenses

Amt. in Rs. April

May

June

July

Aug

Sept.

10,000 8,000 16,000 34,000

12,000 12,000 32,000 56,000

14,900 16,000 48,000 78,900

14,000 20,000 64,000 98,000

12,000 24,000 80,000 1,16,000

15,000 28,000 96,000 1,39,000

8,000 12,000 12,000 32,000

12,000 24,000 5,000 41,000

16,000 36,000 7,800 59,800

20,000 48,000 2,950 70,950

24,000 60,000 27,000 1,11,000

28,000 72,000 20,000 1,20,000

Group-II : Paper-8 : Cost & Management Accounting

C. Surplus (Deficit) [A – B] 2,000 Financing and investment : D. Borrowings 10,000 E. Sales of securities F. Less : Repayment of borrowings G. Less : Interest on borrowings H. Less : Purchase of securities I. Closing cash balance 12,000 [C +D +E – F – G –H]

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49

15,000

19,100

27,050

5,000

19,000

100 14,900

5,000 100 14,000

5,000 50 10,000 12,000

10,000 15,000

19,000

Answer 19. (b) Zero Based Budgeting – ZBB is a method of budgeting whereby all activities are re-evaluated each time a budget is formulated. It is an approach to budget review and evaluation that requires a manager to justify the resources requested for all activities and projects, including ongoing activities and projects, in rank order. Each functional budget starts with the assumption that the function does not exist and it is at zero cost. Increments of costs are compared with increments of benefit, culminating in the planned maximum benefit for a given budgeted cost. Difference between Zero Base Budget and Traditional Budgeting : Points of difference Frequency Starting point Basis Budgeted amount

Traditional budgeting Annual Last year’s budget Last year + % Usually single amount

Priority of activities Alternatives People involved Awareness necessary

‘Musts’ and ‘wants’ not differentiated Often ignored Boss and subordinate Knowledge of own function

Preparation Appropriateness

Can be minimal General activities

Zero Based Budgeting Every 3-5 years Zero Careful analysis of decision packages Depends upon analysis of benefits from incremental spending Distinguished ‘musts’ and ‘wants’ and rank priorities Considered Cross-functional team Comprehensive understanding of how the whole business works Substantial Most effective in Support type activities

Q. 20. (a) A Ltd. produces and sells a single product. Sales budget for the calendar year 2011 by quarter is as under : Quarter

No. of units to be sold

I II III IV

12,000 15,000 16,500 18,000

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Revisionary Test Paper (Revised Syllabus-2008)

[ December ¯ 2011 ]

The year 2011 is expected to open with an inventory of 4,000 units of finished product and closed with an inventory of 6,500 units. Production is customarily scheduled to provide for two-thirds of the current quarter’s sales demand plus one-third of the following quarter’s demand. Thus, production anticipates sales volume by about one month. The standard cost details for one unit of the product is as follows : Direct materials 10 lbs @ 50 paise per lb. Direct labour 1 hr. 30 mins. @ Rs. 4 per hour Variable overheads 1 hr. 30 mins. @ Re. 1 per hr. Fixed overheads 1 hr. 30 mins. @ Rs. 2 per hr. based on a budgeted production volume of 90,000 direct labour hrs. for the year. (i) Prepare a production budget for 2011, by quarters, showing the number of units to be produced and the total costs of direct material, direct labour, variable overheads and fixed overheads. (ii) If the budgeted selling price per unit is Rs. 17, what would be the budgeted profit for the year as a whole? (iii) In which quarter of the year is the company expected to break-even? (b) How flexible budget can help in management decision making? Answer 20. (a) (i)

Quarter Budgeted Production (units)

I II III IV

13,000 15,500 17,000 18,500 64,000

Notes : (a) Budgeted Production : I: 2/3 × 12,000 = 1/3 × 15,000 = II:

2/3 × 15,000 1/3 × 16,500

= =

III :

2/3 × 16,500 1/3 × 18,000

= =

IV:

2/3 × 18,000 = Closing inventory =

8,000 5,000 13,000 10,000 5,500 15,500 11,000 6,000 17,000 12,000 6,500 18,500

Budgeted Costs Direct materials

Direct labour

65,000 77,500 85,000 92,500 3,20,000

78,000 93,000 1,02,000 1,11,000 3,84,000

Variable overheads 19,500 23,250 25,500 27,750 96,000

Fixed overheads 45,000 45,000 45,000 45,000 1,80,000

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(b) Fixed overhead for the year : 90,000 hrs. @ Rs. 2 = Rs. 1,80,000. This is divided equally for the four quarters, i.e., Rs. 1,80,000 ÷ 4 = Rs. 45,000 per quarter.

(ii)

Rs. Budgeted Selling Price per unit Less : Budgeted Variable costs : Direct material Direct labour Variable overheads Unit contribution Total budgeted contribution (61,500 units @ Rs. 4.50) Less : Fixed costs Budgeted profit for the year

(iii) Break-even point =

5.00 6.00 1.50

Rs. 17.00

12.50 4.50 2,76,750 1,80,000 96,750

Rs. 1,80,000 Fixed Cost = = 40,000 units. Unit Contribution Rs. 4.50

Quarter I II III IV

Sales demand 12,000 15,000 16,500 18,000

Cum. Sales Demand 12,000 27,000 43,500 61,500

Thus, A Ltd. will break-even in the later part of Quarter III.

Answer 20. (b) Flexible budget is a budget which, by recognising the difference in behaviour between fixed and variable costs in relation to fluctuations in out, turnover, or other variable factors, etc. It is designed to change in relation to the level of activity actually attained. A flexible budget is one that takes account of a range of possible volumes. It is sometimes referred to as a multi-volume budget. The range of possible outputs may be known as the relevant range. Flexing a budget takes place when the original budget is deliberately amended to take account of change in activity levels. Flexible budget enable an organization to predict its performance and income levels at a given range of sales levels and activity levels. It can be seen the impact of changes in sales and production levels on revenue, expenses and ultimately income. It enables more accurate assessment of managerial and organizational performance. So, Flexible budget is an important aid to management to decision making.

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Revisionary Test Paper (Revised Syllabus-2008)

[ December ¯ 2011 ]

Q. 21. (a) Z Ltd. provides you the following information : Balance Sheet as at 31.3.2010 Liabilities Share capital Retained earnings Creditors Bills payable Provision for taxation

Rs. 4,00,000 32,000 10,000 6,000 20,000

Assets Plant & Machinery Original cost 4,00,000 Less : Depreciation 1,00,000 Stock of raw material Stock of finished goods Debtors Bills receivables Cash

4,68,000

Additional information :

Rs.

3,00,000 38,000 80,000 20,000 10,000 20,000 4,68,000

Rs.

Purchase of machinery during 2010-2011

40,000

Outstanding debtors

46,000

Outstanding creditors

11,000

Credit sales

4,40,000

Credit purchases

1,40,000

Closing stock of raw material

52,000

Closing stock of finished goods

66,900

Direct labour consumed & paid

70,000

Factory overheads (including depreciation for Rs. 20,000)

95,000

Selling, distribution & admn. Expenses

60,300

Income tax is levied @ 50% and paid in the following year Re bill receivables : To be drawn To be endorsed to trade creditors To be collected

4,000 1,000 10,000

Re bill payables : To be accepted

5,000

To be discharged

7,000

Budgeted profit for 2010-2011 Income-tax is to be provided @ 50% Required : Prepare cash budget and budgeted balance sheet. (b) What is difference between Forecast and Budget?

75,600

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Answer 21. (a) The Cash Budget For the year ending 31st March 2011 Particulars

Rs.

Opening cash balance Add : Receipts from debtors (as per schedule I) Collection on account of B/R Less : Payments : Payment for material purchases (creditors + B/P) Direct labour consumed & paid Cash factory overheads (Rs. 95,000 – Rs. 20,000) Selling distribution & admn. Expenses Payment of taxes (of last year) Machinery purchases Closing cash balance

Rs. 20,000

4,10,000 10,000 1,40,000 70,000 75,000 60,300 20,000 40,000

4,20,000

4,05,300 34,700

The budgeted balance sheet As at 31st March 2011 Liabilities Share capital Retained earnings Creditors Bills payable Provision for taxation [ 50% of Rs. 75,600]

Rs. 4,00,000 69,800 11,000 4,000 37,800

Assets Plant & machinery Original cost Less : Depreciation Stock of raw materials Stock of finished goods Debtors Bills receivables Cash

Rs. 4,40,000 1,20,000

5,22,600 Working notes : Schedule –I – Receipts from Debtors Opening debtors Add : Credit sales Less : Bills Drawn Closing debtors Collection from debtors

Rs. 20,000 4,40,000 4,000 46,000 4,10,000

3,20,000 52,000 66,900 46,000 3,000 34,700 5,22,600

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Revisionary Test Paper (Revised Syllabus-2008)

Schedule –II – Closing Balance of Bills Receivables Opening balance Add : Drawn during the year Less : Endorsed to creditors Collected Closing balance

Rs. 10,000 4,000 1,000 10,000 3,000

Schedule –III – Payment to creditors

Rs.

Opening creditors Add : Credit purchases Less : Closing creditors Bills accepted B/R endorsed Payment to creditors

10,000 1,40,000 11,000 5,000 1,000 1,33,000

Schedule –IV – Closing Balance of Bills Payable

Rs.

Opening balance Add : Accepted during the year Less : Discharged during the year Closing balance

6,000 5,000 7,000 4,000

Answer 21. (b) Difference between Forecast and Budget Forecast

Budget

1. Forecast is merely an estimate of what is likely to happen. It is a statement of probable events which are likely to happen under anticipated conditions during a specified period of time.

1. Budget shows the policy and programme to be followed in a period under planned conditions.

2. Forecasts, being statements of future events, do not connote any sense of control.

2. A budget is a tool of control since it represents actions which can be shaped according to will so that it can be suited to the conditions which may or may not happen.

3. Forecasting is a preliminary step for budgeting. It ends with the forecast of likely events.

3. It begins when forecasting ends. Forecasts are converted into budget.

4. Forecasts are wider in scope and it can be made in those spheres, also where budgets cannot interfere.

4. Budgets have limited scope. It can be made of phenomenon capable of being expressed quantitatively.

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Q. 22. ABC Ltd. manufactures two products using one type of material and one grade of labour. Shown below is an extract form the company’s working papers of the next period’s budget. Particulars

Product A

Budgeted sales (units) Budgeted material consumption per product (kg) Budgeted material cost Rs. 12 per kg. Standard hours allowed per product Budgeted wage rate Rs. 8 per hr.

Product B

3,600 5

4,800 3

5

4

Overtime premium is 50% and is payable, if a worker works for more than 40 hrs. a week. There are 90 direct workers. The target productivity ratio (or efficiency ratio) for the productive hours worked by the direct workers in actually manufacturing the products is 80%; in addition the non productive downtime budgeted at 20% of the productive hrs. worked. There are twelve 5 day weeks in the budget period and it is anticipated that sales and production will occur evenly throughout the whole period. It is anticipated that stock at the beginning of the period will be : Product A – 1,020 units; Product B – 2,400 units; Raw material 4,300 kgs. The target closing stock expressed in terms of anticipated activity during the budget period are : Product A – 15 days sales; Product B – 20 days sales; Raw material 10 days consumption. Required : Calculate the Material Purchases Budget and the Wages Budget for the direct workers, showing the quantities and values, for the next period. Answer 22. Material Purchase Budget (in quantities and value) Particulars

Product A

Budgeted production (units) Material consumption (kg.)

3,480 17,400 (3,480 units × 5 kgs.) Add : Closing balance of material (kg) Less : anticipated opening balance of material (kg) Total quantity of material (kg) to be purchased Total value of material to be purchased (Rs.) (30,000 kg × Rs. 12)

Product B 4,000 12,000 (4,000 units × 3 kg.)

Total 29,400 4,900 4,300 30,000 3,60,000

Direct Workers Wages Budget (Showing hours required and wages paid) Standard hours for Product A (3,480 units × 5 hrs.) Standard hour for Product B (4,000 units × 4 hours) Total standard hours Standard hours at 80% efficiency ratio (33,400 × 100/80) Add : Non productive downtime (20% × 41,750 hours) Total labour hours required Less : Normal labour hours (90 workers × 60 days × 8 hours) Overtime hours available Wages for normal hours (Rs.) (43,200 hours × Rs. 8) Overtime wages (Rs.) (6,900 × Rs. 12) Total wages

17,400 16,000 33,400 41,750 8,350 50,100 43,200 6,900 3,45,600 82,800 4,28,400

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Revisionary Test Paper (Revised Syllabus-2008)

[ December ¯ 2011 ]

Working notes : (i) Closing stock of Products A and B Budgeted period of sales (in days) = 12 weeks x 5 days = 60 days Closing stock of Product A (units) (15 days sales) =

3,600 units × 15 days = 900 units 60 days

Closing stock of Product B (Units) (20 days sales) =

4 ,800 units × 20 days = 1,600 units 60 days

(ii) Production Budget (units) Particulars Sales (units) (60 days) Add : Closing stock balance Less : Anticipated opening balance Total number of units to be produced (iii) Closing balance of material for 10 days of its consumption =

=

Product A

Product B

3,600 900 1,020 3,480

4,800 1,600 2,400 4,000

Total material consumption × 10 days 60 days

29,400 kgs. × 10 days = 4,900 kgs. 60 days

Q. 23. In a manufacturing process, the following standards apply : Standard price : Raw material A @ Re. 1 per kg. Standard price : Raw material B @ Rs. 5 per kg. Standard mix : 75% A; 25% B Standard yield (weight of product as a percentage of weight of raw materials) : 90% In a period, the actual material costs, usage, and output were : Used : 8,800 kgs. A, Costing Rs. 9,300 3,200 kgs. B, Costing Rs. 15,700 Output : 11,340 kgs. Of products The budgeted output for the period was 14,400 kgs. Prepare a material cost operating statement, showing how the material cost variance is built up of activity and yield percentage. Answer 23. Material Cost Operating Statement Actual cost of material (Rs. 9,300 + Rs. 15,700) Price variance Standard cost of material (8,800 + 16,000) Mix variance Standard cost of input Yield variance Standard cost of output

Analysis (Rs.) Variance (Rs.) 25,000 200 (200) 24,800 800 (800) 24,000 1,200 1,200 25,200

Total (Rs.) 25,000 200 25,200

Group-II : Paper-8 : Cost & Management Accounting

[ December ¯ 2011 ]

Workings : Percentage of activity is (90% of 12,000 kgs.) Therefore, Yield percentage =

10,800 × 100 = 75% 14 ,400

11,340 × 100 = 105% 10,800

Materials

Standard cost Kgs. Rs.

A B

9,000 3,000 12,000 1,200 10,800

Loss

9,000 15,000 24,000 — 24,000

Actual cost Kgs.

Rs.

8,800 3,200 12,000 660 11,340

9,300 15,700 25,000 — 25,000

Therefore, material cost variance = Rs. 25,200 – Rs. 25,000 = Rs. 200 (F) Standard cost =

11,340 × 24 ,000 = Rs. 25,200 10 ,800

Analysis of variance (i) Material price variance = (Standard Price – Actual Price) × Actual Quantity ⎛ 9 ,300 ⎞ A = (Re. 1 – Rs. 1.057) i.e. ⎜ ⎟ × 8,800 = Rs. 500 (A) ⎝ 8 ,800 ⎠ ⎛ 15,700 ⎞ B = (Rs. 5.00 – 4.91) i.e. ⎜ ⎟ × 3,200 = Rs. 300 (A) ⎝ 3,200 ⎠

Therefore, Total = Rs. 500 (A) – Rs. 300 (F) = Rs. 200 (A) (ii) Mix variance = (Standard mix of actual quantity – Actual mix of actual input) × Standard Price A = (9,000 – 8,800) × Re. 1 = Rs. 200 (F) B = (3,000 – 3,200) × Rs. 5 = Rs. 1,000 (A) Rs. 800 (A) (iii) Yield variance = = Check

Standard Cost × (Standard loss – Actual loss) Unit of output 24,000 × (1,200 – 660) = Rs. 1,200 (F) 10,800

Price variance Mix variance Yield variance Total mat. Cost variance

Rs. 200 (A) Rs. 800 (A) Rs. 1,200 (F) Rs. 200 (F)

57

58

Revisionary Test Paper (Revised Syllabus-2008)

[ December ¯ 2011 ]

Q. 24. Modern Toys Ltd. has budgeted the following sales for January, 2011. Toy A 900 units @ Rs. 50 per unit Toy B 650 units @ Rs. 100 per unit Toy C 1,200 units @ Rs. 75 per unit As against this, the actual sales were : Toy A 1,000 units @ Rs. 55 per unit Toy B 700 units @ Rs. 95 per unit Toy C 1,100 units @ Rs. 78 per unit. The cost per unit of A, B and C were Rs. 45, Rs. 85 and Rs. 65 respectively. Compute the different variances to explain the difference between the budgeted and actual profit. Answer 24. For finding out sales variances, the following figures are necessary : 1. Budgeted profit 2. Actual profit 3. Standard profit, and 4. Revised standard profit.

Budgeted selling price Budgeted cost Profit per unit % profit Actual selling price Budgeted cost Actual profit per unit

Toy A

Toy B

Toy C

50 45 5 10 55 45 10

100 85 15 15 95 85 10

75 65 10 13 1/3 78 65 13

Standard and revised standard profits can be found out by applying the budgeted profit percentage on standard and revised standard sales. Hence, it is necessary to ascertain these two first : Toy A B C Total

Units 900 650 1,200 2,750

Budgeted sales Price (Rs.) Value (Rs.) 50 45,000 100 65,000 75 90,000 2,00,000

Ratio 22.50 32.50 45.00 100.00

Group-II : Paper-8 : Cost & Management Accounting

Toy

A B C

Actual quantity 1,000 700 1,100 2,800

Standard sales Standard price 50 100 75

Value 50,000 70,000 82,500 2,02,500

[ December ¯ 2011 ]

Revised standard sales Standard Budgeted Revised standard sales (Total) ratio sales 2,02,500 22.50 45,562 32.50 65,813 45.00 91,125 2,02,500

Statement of Comparative Profits Toy

Budget (Rs.)

Actual (Rs.)

Standard (Rs.)

A B C

4,500 9,750 12,000 26,250

10,000 7,000 14,300 31,300

5,000 10,500 11,000 26,500

Revised Standard (Rs.) 4,556 9,872 12,150 26,578

Calculations (Toy A) : Budgeted profit :

Budgeted quantity × Budgeted profit p.u. 900 (50 – 45) = Rs. 4,500 Actual profit : Actual quantity × Actual profit per unit 1,000 × Rs. 10 = Rs. 10,000 Standard profit : Actual quantity × Budgeted profit p.u. 1,000 (50 – 45) = Rs. 5,000 Revised standard profit : Revised Standard Sales × Budgeted Profit Percentage ⎛ 4 ,500 ⎞ ⎟ = Rs. 4,556. 45,562 × ⎜ ⎝ 45,000 ⎠ Similar calculations are made for Toy B and Toy C. Calculation of variances : Total profit variance due to sales : Actual profit – Budgeted profit Toy A B C Total

Actual profit (Rs.)

Budgeted profit (Rs.)

Variance (Rs.)

10,000 7,000 14,300 31,300

4,500 9,750 12,000 26,250

5,500 (F) 2,750 (A) 2,300 (F) 5,050 (F)

Standard profit (Rs.) 5,000 10,500 11,000 26,500

Variance (Rs.) 5,000 (F) 3,500 (A) 3,300 (F) 4,800 (F)

Profit variance due to selling price : Actual profit – Standard profit Toy A B C Total

Actual profit (Rs.) 10,000 7,000 14,300 31,300

59

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Revisionary Test Paper (Revised Syllabus-2008)

[ December ¯ 2011 ]

Profit variance due to sales volume : Standard profit – Budgeted profit Toy A B C Total

Standard profit (Rs.) 5,000 10,500 11,000 26,500

Budgeted profit (Rs.) 4,500 9,750 12,000 26,250

Variance (Rs.) 500 (F) 750 (F) 1,000 (A) 250 (F)

Profit variance due to Sales Volume can be further analysed as follows : Profit variance due to quantity : (Revised Standard Profit – Budgeted Profit) Toy A B C Total

Revised Standard profit (Rs.) 4,556 9,872 12,150 26,578

Budgeted profit (Rs.) 4,500 9,750 12,000 26,250

Variance (Rs.) 56 (F) 122 (F) 150 (F) 328 (F)

Profit variance due to sales mix : (Standard Profit – Revised Standard Profit) Toy A B C Total

Standard profit (Rs.) 5,000 10,500 11,000 26,500

Revised Standard profit (Rs.) 4,556 9,872 12,150 26,578

Variance (Rs.) 444 (F) 628 (F) 1,150 (A) 78 (A)

Profit and Loss Statement Particulars

Toy A

Toy B

Toy C

Budgeted sales

45,000

65,000

90,000

2,00,000

Less : Budgeted Cost of sales

40,500

55,250

78,000

1,73,750

4,500

9,750

12,000

26,250

56

122

150

328

444

628

(-) 1,150

(-) 78

500

750

(-) 1,000

250

Standard profit on sales

5,000

10,500

11,000

26,500

Sales price variance

5,000

(-) 3,500

3,300

4,800

Actual profit on sales

10,000

7,000

14,300

31,300

Budgeted profit

Total

Variances : Sales quantity Sales mix

Note : (-) indicates unfavourable or adverse variance.

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Q. 25. Suman Ltd. manufactures a product and provides you the following information : Budgeted data Direct materials - Rs. 4,00,000 Direct labour - Rs. 4,00,000 Variable overheads - Rs. 80,000 Fixed overheads - Rs. 2,00,000 Sales (10,000 units) - Rs. 13,50,000 No opening and closing stock. Favourable (Rs.) Material price variance Material usage variance Labour rate variance Labour efficiency variance Idle time variance Variable overhead efficiency variance Variable overhead expenditure variance Fixed overhead efficiency variance Fixed overhead capacity variance Fixed overhead expenditure variance Sales price variance Sales margin volume variance

Adverse (Rs.) 66,000 10,000 6,800 12,000 8,000 2,400

6,400 6,000 34,000 16,000 40,000 54,000

Required : (a) Prepare a Standard Cost sheet (b) Prepare a statement showing total Standard Cost for Actual Output (c) Prepare Actual Cost sheet (d) Reconcile the Actual Profit with the Standard Profit. Answer 25. Statement showing Standard Cost Sheet, Total Standard Cost for Actual Output and Actual Cost Sheet Particulars A

Direct material Direct labour Variable overhead Fixed overhead Total cost Net profit Sales

Original budget for 10,000 units B 4,00,000 4,00,000 80,000 2,00,000 10,80,000 2,70,000 13,50,000

Standard Cost per unit C=B/10,000 40 40 8 20 108 27 135

Standard Cost for 8,000 units D = C × 8,000

Variance E

Actual for 8,000 units F=D±E

3,20,000 3,20,000 64,000 1,60,000 8,64,000 2,16,000 10,80,000

(-) 76,000 (-) 26,800 4,000 (-) 24,000 (-) 1,22,800 (-) 82,800 40,000

3,96,000 3,46,800 60,000 1,84,000 9,86,800 1,33,200 11,20,000

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Revisionary Test Paper (Revised Syllabus-2008)

Statement Reconciling the Actual Profit with the standard Profit Rs. Budgeted profit (10,000 @ Rs. 27) Less : Adverse sales margin volume variance [Rs. 27.5 (8,000 – 10,000)] Standard profit Add : Sales price variance [8,000 (Rs. 135 – Rs. 140)] Profit before adjustment of cost variances Adjustment of cost variances : Favourable (Rs.) Material price variance Material usage variance Labour rate variance Labour efficiency variance Idle time variance Variable overhead efficiency variance Variable overhead expenditure variance Fixed overhead efficiency variance Fixed overhead capacity variance Fixed overhead expenditure variance

2,70,000 (-) 54,000 2,16,000 40,000 2,56,000 Adverse (Rs.) 66,000 10,000 6,800 12,000 8,000 2,400

6,400 6,000 34,000 16,000 22,400

Actual profit

1,45,200

(-) 1,22,800 1,33,200

Working note : Calculation of Actual Output Sales margin volume variance = Budgeted margin per unit x (Budgeted Qty. – Actual Qty.) Rs. 54,000 = 27 × (10,000 – Actual Qty.) Actual Qty. = 10,000 –

Rs. 54,000 27

Actual Qty. = 10,000 – 2,000 = 8,000 units.

Q. 26. (a) ABC Ltd. is manufacturing and selling two products Black and White at selling price of Rs. 3 and Rs. 4 respectively. The following sales strategy has been outlined for the year. 1. Sales planned for year will be Rs. 7.20 lakhs in the case of Black and Rs. 3.50 lakhs in the case of White. 2. To meet competition, the selling price of Black will be reduced by 20% and that of White by 12 ½%. 3. Break-even is planned at 60% of the total sales of each product. 4. Profit for the year to be achieved is planned as Rs. 69,120 in the case of Black and Rs. 17,500 in the case of White. This would be possible by launching a cost reduction programme and reducing the present annual fixed expenses of Rs. 1,35,000 allocated as Rs. 1,08,000 to Black and Rs. 27,000 to White.

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Required : (i) Calculate the total number of units of Black and White to be sold during the year and number of units to be sold of Black and White to break-even. (ii) Calculate the reduction in fixed expenses product-wise that is envisaged by the Cost Reduction Programme. (b) What is the meaning of Performance Budgeting? Answer 26. (a) Calculation of no. of units to be sold and BEP (Units) Particulars Sales (Rs.) Selling price / unit (revised) Sales units BEP (%) BEP (units)

Black

White

7,20,000 2.4 (80% of 3) 3,00,000 60% 1,80,000

3,50,000 3.5 (87.5% of 4) 1,00,000 60% 60,000

Calculation of Reduction in Fixed Expenses Product-wise Particulars Margin of safety (MS) [Sales units × (100 – BEP%) × Selling Price] Profit (given) Previous fixed cost (given) New P/V ratio [(Profit/ MS) × 100] Break-even sales [Sales units × BEP% × Selling price] Revised fixed cost (BES × P/V ratio) Reduction in fixed cost

Black 2,88,000 (3,00,000 × 40% × 2.4) 69,120 1,08,000 24% 4,32,000 (3,00,000 × 60% × 2.4) 1,03,680 4,320

White 1,40,000 (1,00,000 × 40% × 3.5) 17,500 27,000 12.5% 2,10,000 (1,00,000 × 60% × 3.5) 26,250 750

Answer 26. (b) It is the process of analyzing, identifying, simplifying and crystalising specific performance objectives, of a job to be achieved over a period, within the framework of Firm’s Overall objectives, the purposes and objectives of the job. Features and advantages : (i) Performance budgeting lays immediate stress on the achievement of specific goals over a period of times. (ii) It aims at a continuous growth of the Firm so that it continues to meet the dynamic needs of its growing clientele and customers. (iii) It enables the Firm to be sensitive and adaptive, preventing it from developing rigidities which may retard the process of growth. (iv) It requires the preparation of periodic performance reports, which compare budget and actual performance to find our existing variance.

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Revisionary Test Paper (Revised Syllabus-2008)

Q. 27. Cable Network Ltd (CNL), a large cable television operator, had 7,50,000 subscribers last year, CNL employs 5 customer help-desk representatives to respond to customer questions and problems. During last year, each customer help-desk representatives worked 8 hrs. per day for 250 days at a fixed annual salary of Rs. 2,40,000. CNL received 45,000 telephone calls from its customers during last year. Each call took an average of 10 minutes. Required : (i) Do you think customer help-desk costs at CNL are Engineered Costs or Discretionary Costs ? Explain. (ii) Where possible, calculate the cost of unused Customer Help-Desk capacity last year under each of the following assumptions – (a) Customer help-desk costs are engineered costs, and (b) Customer Help-desk costs are discretionary costs. If you could not calculate the amount and cost of unused capacity, indicate why not. (iii) Assume that CNL had 9,00,000 subscribers this year and that same percentage of telephone calls received to total subscribers for last year continued into this year also. Customer helpdesk capacity this year was the same as it was in last year. Where possible, calculate the cost of unused customer help-desk capacity this year under each of the following two assumptions - (a) Customer help-desk costs are engineered costs, and (b) Customer Help-desk costs are discretionary costs. If you could not calculate the amount and cost of unused capacity, indicate why not. Answer 27. (i) Nature of Customer Help-desk costs : There is a cause-and-effect relationship between output (number of subscribers/ customers) and the inputs (Customers help-desk representatives) needs to serve customers and the related costs. If more customers/ subscribers join in, there will be increase in the expected number of calls. This requires the recruitment of more help-desk representatives. Thus, customer help-desk costs are indirect, engineered costs only. (ii) Cost of unused capacity last year (a) When customer help-desk costs are considered as engineered costs Customer help-desk capacity available (5 persons × 8 hrs × 250 days) Customer help-desk capacity utilized last year (45,000 calls × 10/60 hours) Hence, unused customer help-desk capacity Customer help-desk capacity costs ( 5 persons × Rs. 2,40,000) ÷ 10,000 hrs Cost of unused customer help-desk capacity (Rs. 120 per hr. × 2,500 hrs.)

10,000 hrs 7,500 hrs 2,500 hrs Rs. 120 per hr. Rs. 3,00,000

(b) When customer help-desk costs are assumed as discretionary costs, the cost of unused capacity cannot be determined since the relationship between inputs required and outputs desired, cannot be established. (iii) Cost of unused capacity this year (a) When customer help-desk costs are considered as Engineered Costs No. of calls received this year = (45,000 ÷7,50,000) × 9,00,000 Customer help-desk capacity available (5 persons × 8 hrs. × 250 days) Customer help-desk capacity utilized this year (54,000 calls × 10/60 hrs) Hence, unused customer help-desk capacity Customer help-desk capacity costs (5 persons × Rs. 2,40,000) ÷ 10,000 hrs Cost of unused customer help-desk capacity (Rs. 120 per hr. × 1,000 hrs.)

54,000 calls 10,000 hrs 9,000 hrs 1,000 hrs Rs. 120 per hr. Rs. 1,20,000

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(b) When customer help-desk costs are assumed as discretionary costs, the cost of unused capacity cannot be determined since the relationship between inputs required and outputs desired, cannot be established. Q. 28. (a) What are the limitations of value chain analysis? (b) What are the components of cost to be reported in a Cost of Quality Report? Answer 28. (a) Value Chain Analysis is criticized on the following grounds – (i) Non-availability of data – Internal data on costs, revenues and assets used for Value Chain Analysis are derived from financial information of a single period. For long-term strategic decision-making, changes in cost structures, market prices and capital investments etc. may not be readily available. (ii) Identification of stages – Identifying stages in an industry’s Value Chain is limited by the ability to locate at least one Firm that participates in a specific stage. Breaking a value stage into two or more stages when an outside Firm does not compare in these stages in strictly judgmental. (iii) Ascertainment of costs, revenue and assets – Finding the costs, revenues and assets for each Value Chain activity poses/ gives rise to serious difficulties. There is no scientific approach and much depends upon trial and error and experimentation methods. (iv) Identification of cost drivers – Isolating cost drivers for each value-creating activity, identifying Value Chain Linkages across activities, and computing supplier and customer profit margins present serious challenges. (v) Resistance from employees – Value Chain Analysis is not easily understandable to all employees and hence may face resistance from employees as well as managers. (vi) Science vs. Art – Value Chain Analysis is not an exact science. It is more ‘art’ than preparing precise accounting reports. Certain judgments and factors of analysis are purely subjective and differ from person to person. Answer 28. (b) (i) Prevention Costs – These are incurred in preventing the production of products that do not conform to specification. They include the costs of preventive maintenance, quality planning and training and the extra costs of acquiring higher quality raw materials. (ii) Appraisal costs – These are incurred to ensure that materials and products meet quality conformance standards. They include the costs of inspecting purchased parts, work in process and finished goods, quality audits and field test. (iii) Internal failure costs – These are associated with materials and products that fail to meet quality standards. They include costs incurred before the product is dispatched to the customer, such as the costs of scrap, repair, downtime and work stoppages caused by defects. (iv) External failure cost – These are incurred when inferior products are delivered to customers. They include the costs of handling customer complaints, warranty replacement, repairs of returned products and the costs arising from a damaged company reputation. Prevention and Appraisal Costs are called Costs of Quality Compliance while Internal and External Failure Costs are called Costs of Non-Compliance.

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Revisionary Test Paper (Revised Syllabus-2008)

[ December ¯ 2011 ]

Q. 29. (a) Bharati Enterprises has decided to adopt JIT policy for materials. The following effects of JIT policy are identified : (i) To implement JIT, the company has to modify its production and material receipt facilities at a capital cost of Rs. 6,00,000. The new facilities will require a cash operating cost of Rs. 48,000 per annum. (ii) Raw material stockholding will be reduced from Rs. 28,00,000 to Rs. 8,00,000. (iii) The company can earn 15% on its long-term investments. (iv) The company can avoid rental expenditure on storage facilities amounting to Rs. 30,000 per annum. Property taxes and insurance amounting to Rs. 12,000 will be saved due to JIT programme. (v) Presently there are 7 workers in the Stores Department at a salary of Rs. 3,000 each per month. After implementing JIT scheme, only 2 workers will be required in this Department. Of the balance 5 workers, 3 will be transferred to other departments, while 2 workers’ employment will be terminated. (vi) Due to receipt of smaller lots of raw materials, there will be some disruption of production. The costs of stock-out will be Rs. 3,40,000 in the first year only. This stock-out costs can be brought down from the second year onwards. Determine the financial impact of the JIT policy. Is it advisable for the company to implement JIT system? (b) What are the advantages of Target Costing? Answer 29. (a) Cost – Benefit Analysis of JIT policy Costs Interest on capital for modifying production facilities (Rs. 6,00,000 × 15%) Operating costs of new production facilities Stock-out costs (first year only)

Total

Rs.

Benefits

Rs.

90,000 Interest on investment on released 3,00,000 funds (Rs. 28,00,000 – Rs. 8,00,000) × 15% 48,000 Savings in salary of 2 workers terminated 72,000 (Rs. 3,000 × 12 months × 2) 3,40,000 Savings in rental expenditure 30,000 Saving in Property taxes & insurance 12,000 Net loss due to JIT policy (first year) 64,000 4,78,000 Total 4,78,000

Conclusion : In the first year, JIT policy results in a loss of Rs. 64,000. However, from 2nd year onwards, stock-out costs of Rs. 3,40,000 will not be incurred. Hence, net benefit will be Rs. 2,76,000 per annum from the 2nd year onwards. Hence, the JIT policy may be implemented. Answer 29. (b) The advantages of Target Costing are : (i) Innovation – It reinforces top-to-bottom commitment to process and product innovation, and is aimed at identifying issues to be resolved. (ii) Competitive advantage – It enables a Firm to achieve competitive advantage over other firms in the industry. The Firm which achieves cost reduction targets realistically stands to gain in the long run. (iii) Market driven management – It helps to create a Company’s competitive future with market-driven management for designing and manufacturing products that meet the price required for market success.

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(iv) Real cost reduction – It uses management control system to support and reinforce manufacturing strategies, and to identify market opportunities that can be converted into real savings to achieve the best value rather than simply the lowest cost. Q. 30. (a) List some specific circumstances under which a Cost Audit can be ordered? (b) List some difficulties in implementation of Benchmarking. (c) What do you mean by philosophy of Continuous Process Improvement? What are its challenges? Answer 30. (a) In addition to general reasons for cost audit, the following circumstances may also require a Cost Audit : (i) Price fixation – The need for fixation of retention price in the case of materials of national importance like steel, cement, etc., may create a necessity for cost audit. Also to check excessive profiteering, cost audit may be useful in knowing the true cost of production. (ii) Cost variation within the industry – Where the cost of production varies significantly from unit to unit in the same industry, cost audit may be necessary to find the reasons for such differences. (iii) Inefficient management – Where a factory is run inefficiency and uneconomically, institution of cost audit may be necessary. It may be useful for the Government before taking up any action. (iv) Tax assessment – Where a duty or tax is levied on products based on the cost of production, the levying authorities may require a cost audit to determine the correct cost of production. (v) Trade disputes – Cost audit is useful in settling trade disputes regarding claim for higher wages, bonus etc. Answer 30. (b) Difficulties in implementation of benchmarking are as follows : (i) Time consuming – Benchmarking is time consuming and at times difficult. It has significant requirement of staff time and Company resources. Companies may waste time in benchmarking non-critical functions. (ii) Lack of management support – Benchmarking implementation requires the direct involvement of all managers. The drive to be best in the industry or world cannot be delegated. (iii) Resistance from employees – It is likely that there may be resistance from employees. (iv) Copy –paste attitude – The key element in benchmarking is the adaptation of a best practice to tailor it to a Company’s needs and culture. Without that step, a Company merely adopts another Company’s process. This approach condemns benchmarking to fail leading to a failure of benchmarking goals. Answer 30. (c) In a Process industry, production of a product moves from one process to the next till it is completed. Each Production Department performs some part of the total operation on the product and transfers its completed production to the next process Department, where it becomes the input for further processing. The completed production of the last Department is transferred to the Finished Goods stock. The Philosophy of Continuous Process Improvement believes in encouraging every member of the Firm to continuously strive to efficiently serve their customers, who may either be external or internal. The objective of Continuous Process Improvement is to sustain the improvement momentum in the Firm over time and to align improvement activities in support of strategic objectives. The challenge is in promoting activities that continuously modify processes, procedures, task, content and process interfaces to achieve complete customer satisfaction as well as to reduce costs and to increase product quality.

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